1
Economic, Price and Financial System
Stability, Outlook and Policies
1.1 Overview
R
eal economic growth in Sri Lanka in
2015 registered 4.8 per cent, compared
with 4.9 per cent in 2014. A slowdown
in the growth of demand in Sri Lanka’s traditional
export markets impacted the growth of the export
sector while a strengthening US economy prompted
short term capital outflows. The impact of these
developments was offset to some extent by lower
international commodity prices. Nevertheless,
domestic consumption rebounded as incomes
grew, particularly among public sector workers.
Agriculture and services related activities grew by
5.5 per cent and 5.3 per cent, respectively, while
industry related activities grew by 3.0 per cent
during 2015. Inflation, as measured by the year-
on-year change in the Colombo Consumers’ Price
Index (CCPI), was in negative territory during July-
September 2015, mainly due to subdued commodity
prices. This was the first time that inflation turned
negative since March 1995. However, by end
2015, year-on-year headline inflation was recorded
at 2.8 per cent, compared to 2.1 per cent at the
end of 2014. Correspondingly, core inflation, which
switches out energy and selected food items from
the CCPI basket, grew from 0.8 per cent, on a year-
on-year basis in February 2015, to reach 4.5 per
cent at the end of the year. This was driven primarily
by the enhanced growth of bank credit as well as
higher wages afforded to government workers
and employees in other sectors of the economy.
Meanwhile, despite substantial gains from the
lower oil prices and continued positive trends in
the tourism sector, slowing down of net foreign
exchange inflows, including worker remittances,
and capital outflows, generated an overall deficit in
the balance of payments (BOP). Efforts to reverse
the downward trend in government tax and non-tax
revenues were moderately successful, but overruns
on the expenditure side of the government budget
meant that the budget deficit grew to 7.4 per cent
of Gross Domestic Product (GDP), as against the
targeted deficit of 4.4 per cent. Central government
debt grew to 76.0 per cent of GDP by the end of
2015. The new coalition government formed after
the Presidential election in January 2015 focused
on implementing the 100-day programme before
the general election that was held in August 2015.
The policy responses to volatile global economic
conditions took time to evolve after the general
 CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

Table 1.1 Macroeconomic Performance (2011-2015)

Indicator Unit 2011 2012 2013 2014 (a) 2015 (b)

Real Sector and Inflation

1
Real GDP Growth (c) % 8.4 9.1 3.4 4.9(b) 4.8
GDP at Market Price (c) Rs.bn 7,219 8,732 9,592 10,448(b) 11,183
Per Capita GDP (c) US$ 3,129 3,351 3,610 3,853(b) 3,924
Annual Average Inflation (d) % 6.7 7.6 6.9 3.3 0.9
External Sector
Trade Balance (c) % of GDP -14.9 -13.8 -10.2 -10.4 -10.2
Current Account Balance (c) % of GDP -7.1 -5.8 -3.4 -2.5 -2.4
Overall Balance US$ mn -1,059 151 985 1,369 -1,489
External Official Reserves US$ mn 6,749 7,106 7,495 8,208 7,304
Fiscal Sector (c)
Current Account Balance % of GDP -0.8 -0.9 -0.7 -1.2 -2.2
Overall Balance % of GDP -6.2 -5.6 -5.4 -5.7 -7.4
Central Government Debt % of GDP 71.1 68.7 70.8 70.7 76.0
Monetary Sector (e)
Broad Money Growth (M2b) % 19.1 17.6 16.7 13.4 17.8
Growth in Credit to the Private Sector (in M2b) % 34.5 17.6 7.5 8.8 25.1
(a) Revised Sources: Department of Census and Statistics
(b) Provisional Ministry of Finance
(c) The data is based on the base year 2010 GDP estimates of the Department of Census and Statistics. Central Bank of Sri Lanka
(d) Based on CCPI (2006/07=100)
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

(e) Year-on-year growth based on end year values.

election held in August 2015. In order to address
the adverse implications of growing demand
pressures on price and financial stability and help
cushion pressure on the BOP, the Central Bank
took early corrective action by imparting greater
flexibility in the management of the exchange rate,
enforcing the new macroprudential regulation
of loan to value (LTV) ratio as a selective
demand management instrument and tightening
monetary policy through an upward adjustment
of the Statutory Reserve Requirement (SRR)
and also later increasing the Central Bank’s
policy interest rates. A renewed focus on export
led economic growth and the buttressing of
collection of government revenue to contain the
overhang of government debt are the key drivers
of the government’s medium term economic
strategy, and structural reforms proposed by the
government towards this end are expected to
be endorsed by the International Monetary Fund
(IMF) as well.
It is expected that, with appropriate policies,
the economy will return to a high growth path in
the medium term. Addressing the already identified
constraints faced by the economy, including low
2
government revenue to GDP ratios and excessive
government expenditure, falling exports to GDP
ratios and insufficient inflows of foreign direct
investments (FDI) remain key ingredients to
achieve sustained economic growth in the medium
term. In addition, other structural and emerging
challenges that require the attention of the
government include, putting in place more efficient
systems to ensure the development of required
skills to support the growing demand for high
quality human capital; improving public transport
to curb the economic loss caused by road traffic
congestion; strengthening the national policy on
renewable energy development and ensuring
energy security; introducing robust market based
pricing formulae for energy and public utilities;
addressing issues in the agriculture sector,
including low productivity, lack of diversification,
food insecurity, and inefficiencies in water
management; creating enabling socioeconomic
infrastructure and lucrative livelihood opportunities
amidst constraints on public resources; ensuring
the sustainability of the public sector pension
scheme while introducing market oriented
pension and superannuation schemes that ensure
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

Chart 1.1 Quarterly Real GDP Growth (Year-on-Year)

16.1
18
16

1
14

10.3
12
9.8

9.7
9.2
8.5

8.3
10

8.2
Per cent

8.1
8.0

8.0

7.9

7.8

7.7
7.6
7.6
7.2

7.0
6.8
6.8
6.4

6.4

6.4
6.3
8

6.1

6.0
5.9

5.8

5.6
5.2

5.0
4.8

4.4

4.5
6

4.0
3.6

2.5
4

2.2
1.3
0.5
2
0
2011-Q1

2011-Q2

2011-Q3

2011-Q4

2012-Q1

2012-Q2

2012-Q3

2012-Q4

2013-Q1

2013-Q2

2013-Q3

2013-Q4

2014-Q1

2014-Q2

2014-Q3

2014-Q4

2015-Q1

2015-Q2

2015-Q3

2015-Q4
Base Year 2002 Base Year 2010

the full coverage of the labour force; facilitating (-0.9 per cent) and mining and quarrying (-0.9 per
financial deepening through raising the efficiency cent) activities, industry activities, which account for
of financial intermediation, introducing a diverse 26.2 per cent of GDP, grew by 3.0 per cent, mainly

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

range of financial products and services, and supported by the growth in manufacturing activities
improving access to formal finance as well as (4.7 per cent). Agriculture activities, which account
building external and domestic policy buffers to for 7.9 per cent of GDP, expanded by 5.5 per cent,
sustain a robust growth trajectory over the medium mainly due to the significant growth in growing of
to long term.
rice (23.3 per cent) and vegetables (24.9 per cent),
amidst the contraction in fishing (-2.7 per cent),
1.2 Macroeconomic
growing of rubber (-10.1 per cent) and growing of
Developments, Stability and
tea (-2.6 per cent).
Policy Responses in 2015
As per the expenditure approach, the

Real Sector Developments and growth in real GDP in 2015 was largely driven
Inflation by an increase in consumption demand,
while investment activities made a modest
According to provisional estimates released contribution. Public sector consumption
by the Department of Census and Statistics expenditure grew at a high rate, mainly reflecting
(DCS), the economy grew by 4.8 per cent during
the increase in salaries and wages of public sector
2015 in real terms, compared to 4.9 per cent in
employees in 2015. Private consumption expenditure
2014.1 Services activities, which account for 56.6
also grew during the year, mainly due to the low
per cent of GDP, grew by 5.3 per cent, buttressed by
interest rate environment and increased real wages.
the growth in financial services (15.8 per cent), real
However, investment activities, as measured by
estate activities (9.6 per cent), transport activities
gross capital formation, decelerated during 2015.
(5.5 per cent) and wholesale and retail trade (4.7 per
Meanwhile, as a combined outcome of the increased
cent). Despite the minor slowdown in construction
demand for imports, mainly consumption goods,
1 In July 2015, DCS changed the base year for national accounts statistics to 2010 from
2002, while adopting the United Nation’s System of National Accounts (SNA) 2008
standard. The improved compilation procedure captures the changes in the economic
and weak demand from Sri Lanka’s major export
structure of Sri Lanka over the past decade and introduces new economic activities to the
national accounts system. The rebased GDP estimates had varying effects on macroeco- destinations, net external demand deteriorated, in
nomic indicators. The analysis of the state of the Sri Lankan economy in 2015 provided
in this report is based on new GDP estimates, which are provisional. real terms, during the year.
3
 CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

Savings and Investment dampened national savings in 2015, although

Chart 1.2
(as a percentage of GDP) remittances increased marginally, in rupee terms.
45 Accordingly, national savings declined to 27.8 per
39.1
40
cent of GDP in 2015 from 29.5 per cent of GDP in

1
35 33.4 33.2
32.0
30.1 the previous year. Meanwhile, as the decline in
30
27.2
24.6 24.0 investments as a percentage of GDP was higher than
Per cent

25 22.6
20.2
20 the decline in national savings as a percentage of
15
GDP, the savings-investment gap narrowed during
10

5
2015.
0
2011 2012 2013 2014 2015
The Agriculture sector accelerated its growth
Gross Investment Gross Domestic Savings momentum, increasing its GDP share marginally
to 7.9 per cent in 2015. The value addition from
Domestic savings declined to 22.6 per cent of Agriculture, Forestry and Fishing activities grew by 5.5
GDP in 2015, from 24.0 per cent of GDP in 2014. per cent in 2015, in comparison to the growth of 4.9
per cent in the previous year. This was largely driven
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

An increase in government dissavings, amidst lower

by the expansion in growing of rice, which recorded
than expected government revenue coupled with
a high growth of 23.3 per cent. Paddy production,
an overrun in recurrent expenditure, resulted in the
which was severely affected by extreme weather
deterioration of domestic savings during the year, as
conditions in 2014, increased significantly during
private savings remained broadly unchanged. This, both 2014/2015 Maha and 2015 Yala seasons,
together with the deterioration of net primary income supported by favourable weather conditions
from the rest of the world, along with a reduction in and the increased purchase price of paddy. The
earnings on investment and increased outflows, value addition from several other key sub sectors,

Table 1.2 Aggregate Demand and Savings Investment Gap at Current Market Prices (a)(b)

Rs. billion Growth (%) As a percentage of GDP

Item
2014 2015 2014 2015 2014 2015
1. Domestic Demand 11,285.0 12,013.7 8.3 6.5 108.0 107.4
1.1 Consumption 7,943.8 8,652.2 9.9 8.9 76.0 77.4
Private 7,074.7 7,666.4 9.1 8.4 67.7 68.6
Public 869.1 985.8 16.6 13.4 8.3 8.8
1.2 Investment (Gross Domestic Capital Formation) 3,341.2 3,361.5 4.8 0.6 32.0 30.1
2. Net External Demand -836.5 -830.5 -1.2 0.7 -8.0 -7.4
Export of Goods and Services 2,185.0 2,295.4 12.1 5.1 20.9 20.5
Import of Goods and Services 3,021.5 3,125.9 8.9 3.5 28.9 28.0
3. Total Demand (GDP) (1+2) 10,448.5 11,183.2 8.9 7.0 100.0 100.0
4. Domestic Savings (3-1.1) 2,504.7 2,531.0 6.0 1.1 24.0 22.6
Private 2,632.4 2,777.8 8.3 5.5 25.2 24.8
Public -127.7 -246.8 -88.5 -93.3 -1.2 -2.2
5. Net Primary Income from Rest of the World (c) -236.7 -251.3 -4.7 -6.2 -2.3 -2.2
6. Net Current Transfers from Rest of the World (c) 813.1 833.5 11.6 2.5 7.8 7.5
7. National Savings (4+5+6) 3,081.1 3,113.2 7.5 1.0 29.5 27.8
8. Savings Investment Gap
Domestic Savings - Investment (4-1.2) -836.5 -830.5 -8.0 -7.4
National Savings - Investment (7-1.2) -260.0 -248.3 -2.5 -2.2
9. External Current Account Balance (2 + 5 + 6) (c) -260.0 -248.3 -2.5 -2.2
(a) The data is based on the base year 2010 GDP estimates of the Department of Census and Statistics. Sources: Department of Census and Statistics
(b) Provisional Central Bank of Sri Lanka
(c) The difference with the BOP estimates is due to the time lag in compilation.

4
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

Table 1.3 Gross National Income by Industrial Origin at Constant (2010) Prices (a)(b)

Value As a Share of GDP Rate of Change Contribution to Change

Economic Activity (Rs. million) (%) (%) (%)

1
2014 (c) 2015 2014 (c) 2015 2014 (c) 2015 2014 (c) 2015
Agriculture, Forestry & Fishing 641,493 676,899 7.8 7.9 4.9 5.5 7.8 9.0
Agriculture and Forestry 520,835 559,445 6.3 6.5 5.1 7.4 6.7 9.8
Fishing 120,658 117,453 1.5 1.4 3.7 -2.7 1.1 -0.8
Industries 2,194,167 2,259,223 26.7 26.2 3.5 3.0 19.6 16.5
Mining and Quarrying 202,905 201,036 2.5 2.3 2.2 -0.9 1.2 -0.5
Manufacturing 1,292,994 1,354,083 15.7 15.7 2.3 4.7 7.6 15.5
Electricity, Gas, Water and Waste Treatment 108,157 119,105 1.3 1.4 4.7 10.1 1.3 2.8
Construction 590,111 584,999 7.2 6.8 6.6 -0.9 9.6 -1.3
Services 4,634,805 4,881,273 56.3 56.6 5.2 5.3 59.9 62.6
Wholesale and Retail Trade, Transportation
and Storage, and Accommodation and Food
Service Activities 1,914,236 2,002,655 23.3 23.2 4.0 4.6 19.3 22.5
Information and Communication 44,102 49,613 0.5 0.6 11.6 12.5 1.2 1.4
Financial, Insurance and Real Estate Activities
including Ownership of Dwellings 945,090 1,061,757 11.5 12.3 8.1 12.3 18.6 29.6
Professional Services and Other Personal
Service Activities 1,007,434 1,020,397 12.2 11.8 4.3 1.3 11.0 3.3
Public Administration, Defence, Education,
Human Health and Social Work Activities 723,943 746,852 8.8 8.7 5.5 3.2 9.8 5.8
Gross Value Added at Basic Price 7,470,465 7,817,394 90.8 90.7 4.7 4.6 87.3 88.1
Taxes less Subsidies on Products 758,521 805,431 9.2 9.3 6.9 6.2 12.7 11.9

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

Gross Domestic Product at Market Price 8,228,986 8,622,825 100.0 100.0 4.9 4.8 100.0 100.0
Net Primary Income from Rest of the World -189,495 -196,496 -2.9 -3.7
Gross National Income at Market Price 8,039,492 8,426,330 4.9 4.8
(a) The data is based on the base year 2010 GDP estimates of the Department of Census and Statistics. Source: Department of Census and Statistics
(b) Provisional
(c) Revised

including coconut (a growth of 5.1 per cent), fruits (a
growth of 16.5 per cent), and vegetables (a growth
of 24.9 per cent), also increased in 2015, compared
to the previous year, due to favourable weather
conditions. However, the growing of tea contracted
for the second consecutive year, registering a 2.6
per cent decline, due to supply side factors as well
as in response to demand conditions, including
lower demand from major export destinations.
Growing of rubber also declined by 10.1 per cent,
partly due to the slowdown of tapping operations of
smallholders in response to declining global prices
of rubber. In contrast, animal production activities
grew in 2015, with the increase in milk production,
owing to favourable producer prices for raw milk
and increased capacity of milk factories. However,
value addition from the fisheries sector contracted
with lower production from inland fishing as well as
marine fishing.
In 2015, the government introduced several
measures which contributed to the increase in
output of the Agriculture sector. The increase
in the purchase prices of paddy and raw milk
contributed towards the increased production in
these sectors. Subsidy programmes to promote
replanting and new planting in the tea, rubber and
coconut sectors aimed at improving productivity in
these sectors. The Sri Lanka Tea Board continued
the “B Leaf 60” programme to upgrade the average
best leaf standard of tea and introduced a subsidy
scheme in March 2015 for small holders who provide
quality green leaf. Further, in order to overcome the
financial difficulties faced by tea factory owners,
a short term working capital loan scheme was
implemented by the government, with the Central
Bank providing an interest rate subsidy of 2 per
cent for this scheme. Efforts were taken to fulfill the
conditions laid down by the European Union (EU),
in order to get the ban lifted on fish exports from Sri
Lanka to the EU, which affected Sri Lanka’s overall
fisheries exports in 2015. Agrarian policies proposed
in the Budget for 2016 also aim to make the country
self-sufficient in essential food commodities, through
crop diversification and productivity improvements,
while envisaging a move from subsistence
5

agriculture into an agri-business based economy
with access to export markets. Accordingly, the
Budget proposed several policy measures, including
setting up granaries with state of the art technology
1 for paddy, maize, gingelly, pepper, black gram, etc.
and cold rooms for vegetables and fruits, developing
local fishery harbours, creating an Agro Livestock
and Fish Processing Park as well as the removal of
import duties pertaining to agriculture machinery and
equipment. Initiatives have been taken to provide a
cash grant in place of the existing fertiliser subsidy
allowing greater flexibility for farmers in selecting
farming inputs. In the meantime, with a view to
preventing the use of highly toxic agrochemicals in
the farming sector, a three year national programme
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
was launched in early March 2016 under the theme
“A Wholesome Agriculture - A Healthy Populace - A
Toxin Free Nation.” Further, it has been proposed to
establish 23 Agricultural Development Mega Zones
in order to make Sri Lanka’s agricultural products
globally competitive. As part of the Western Region
Megapolis Master Plan, 13 planning areas have
been proposed, including a Plantation City and a
Forest City.
The growth in the Industry sector slowed down
to 3.0 per cent in 2015, marginally reducing the
share of industry in GDP to 26.2 per cent. The
contraction in construction, and mining and quarrying
activities largely contributed to the slower growth in the
industry sector. However, the major component of the
Industry sector, manufacturing activities, supported the
growth in the sector with an expansion of 4.7 per cent,
largely driven by the manufacturing of food, beverages
and tobacco products. In addition, the manufacture of
machinery and equipment, metals and metal products,
and furniture also supported the growth momentum
in manufacturing activities. Meanwhile, electricity,
water and waste treatment activities also contributed
positively to the overall growth in Industry activities.
The value addition in the manufacture of textiles,
wearing apparel and leather related products
recorded no growth during 2015.
6
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
Government incentives towards
industrial development continued with fiscal
concessions, technical assistance and
upgrading of infrastructure facilities to promote
regional industry development initiatives. The
National Policy Framework for the development of
small and medium scale enterprises (SMEs) has
been formulated by the Ministry of Industry and
Commerce (MIC) and an action plan developed for
its implementation in 20 districts. Initiatives were
taken to encourage commercial banks to enhance
lending to SMEs. The development and upgrading
of Industrial Estates (IE) continued under the
Regional Industrial Development Programme
of the MIC, with an emphasis on lagging areas,
especially the North and the East. Accordingly, the
development of several other industrial cities, as
specialised economic zones spanning across
several districts, is also planned. Keeping in line
with the broad objectives of the government,
the development of a Science and Technology
City enabling the transformation of the country
into a knowledge-based innovation-driven
economy is proposed under the Western Region
Megapolis Master Plan. Fiscal incentives were
aimed at enhancing value addition, private
sector participation, promoting environmentally
sustainable products and knowledge-based
sectors such as Business Process Outsourcing
(BPO) and Information and Communication
Technology (ICT) as well as encouraging the
expansion of micro institutions and SMEs in the
medium term.
The Services sector, which accounts for
56.6 per cent of GDP, grew by 5.3 per cent in
value added terms in 2015, in comparison to a
growth of 5.2 per cent in 2014. The robust growth
of 15.8 per cent in financial service activities, which
benefitted from the relaxed monetary policy stance,
largely contributed to the Services sector growth.
Meanwhile, wholesale and retail trade, and transport
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

activities, the two major Services components departures for foreign employment, which could
grew by 4.7 per cent and 5.5 per cent, respectively. partly be attributed to escalated geo-political
Moreover, IT programming, telecommunication, tensions and the slowdown of economic activity
real estate activities, including the ownership of in the Middle East. This had an impact on the
dwellings and insurance services notably grew
during 2015, supporting the momentum in Services
activities. However, the setback observed in
unemployment rate as well as the labour force
participation rate. 1
Inflation, based on CCPI (2006/07=100),
education services, professional services, postal
remained below mid-single digit levels,
and courier activities, and accommodation, food
supported by the downward adjustment
and beverage services affected the overall growth
of prices of several key consumer items,
in Services activities.
favourable supply side developments in the
domestic and international markets, and well
The unemployment rate increased to 4.6
contained inflation expectations. Headline
per cent during 2015, compared to 4.3 per cent
inflation, as measured by the year-on-year change
recorded in 2014, amidst a marginal increase
of CCPI, declined sharply from 3.2 per cent in

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

in labour force participation, particularly by
females. The female unemployment rate increased
from 6.5 per cent to 7.6 per cent, while the male
unemployment rate declined from 3.1 per cent
to 3.0 per cent in 2015, compared to 2014. The
increase in unemployment among youth and
those with GCE A/L and higher qualifications
was notable. The labour force participation rate
increased to 53.8 per cent in 2015, from 53.3
per cent in 2014, with increased participation
of rural sector females in the labour force.
Labour productivity increased during 2015, with
positive contributions from all three sectors of
the economy. Meanwhile, a sharp decline of 12.4
per cent was observed in the total number of
January 2015 to 0.6 per cent in February 2015,
with the price revisions introduced in the Interim
Budget for 2015. Year-on-year Inflation remained
below 1 per cent thereafter until September 2015,
while recording negative inflation during July-
September 2015. Inflation picked up in the fourth
quarter of 2015, and recorded 2.8 per cent by end
2015. Annual average headline inflation declined
from 3.3 per cent in 2014 to 0.9 per cent in 2015.
Signalling the gradual buildup of demand pressures
in the economy, CCPI based year-on-year core
inflation increased to 4.5 per cent by end 2015 from
3.2 per cent at end 2014, although core inflation in
terms of the annual average declined from 3.5 per
cent in 2014 to 3.1 per cent in 2015. Meanwhile, in

Chart 1.3 Annual Unemployment Rate Chart 1.4 Year-on-Year Headline Inflation

18 12
15.9
14.7
14.6

16 10
13.8
13.1
12.3

14 8
11.3
10.5

12 6
Per cent
9.2
8.9

8.8
Per cent

10
8.4
8.3

4
7.9

7.7
7.6

8
6.5

2
6.0

5.8
5.4

4.9

6
4.6
4.4
4.3
4.2

0
4.0

4
-2
Dec-10
Mar-11
Jun-11
Sep-11
Dec-11
Mar-12
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
Jun-15
Sep-15
Dec-15

0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

CCPI (2006/07=100) NCPI (2013=100)

7

2015, the DCS introduced the National Consumer
Price Index (NCPI, 2013=100), which captures
price movements of all provinces and changes in
consumption patterns based on the findings of the
1 Household Income and Expenditure Survey (HIES,
2012/13). Inflation based on NCPI was at 4.2 per
cent on a year-on-year basis and 3.8 per cent
on an annual average basis by end 2015. Wage
inflation was particularly high in the public sector,
as reflected by the change in the public sector
wage rate indices, which registered 31.7 per cent
in nominal terms and 27.0 per cent in real terms in
2015.
External Sector Developments
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
The performance of Sri Lanka’s external
sector reflected the impact of the changing
global economic environment as well as a
number of developments in the domestic
economy. In spite of the benefit of lower
expenditure on fuel imports, the merchandise trade
deficit widened marginally by 1.7 per cent over the
previous year, due to the increase in non-oil imports
and the slowdown in export earnings. Continued
increase in tourist arrivals and higher spending by
tourists resulted in a growth in earnings from tourism,
which contributed substantially to the improved
performance of the services account during the
year. The deficit in the primary income account
continued to widen in 2015. However, the surpluses
in the secondary income and services accounts
helped abate a large deficit in the external current
account. In absolute terms, the current account
deficit expanded marginally in 2015, although as
a percentage of GDP, the current account deficit
reduced marginally to 2.4 per cent in 2015 from
2.5 per cent in 2014. The modest performance of
the current account, together with the decline in
inflows to the financial account, in the form of FDI
and loans to the government, banking and private
sectors and the withdrawal of foreign investments
from the government securities market, resulted
8
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
in the balance of payments (BOP) recording a
deficit of US dollars 1,489 million. Along with
the deterioration of the BOP, the country’s gross
official reserves declined to US dollars 7.3 billion by
end 2015 from US dollars 8.2 billion at end 2014.
Meanwhile, the rupee, which remained broadly
stable during the first eight months of the year,
depreciated at a faster pace from early September
with the Central Bank’s decision to allow greater
flexibility in the determination of the exchange rate,
based on market forces. Accordingly, as of end 2015,
the rupee had recorded a depreciation of 9.03 per
cent against the US dollar.
The deficit in the trade account expanded by
1.7 per cent in 2015 in nominal terms, although
as a percentage of GDP, it declined marginally.
Despite the slowdown in expenditure on imports, the
greater decline in exports resulted in the expansion
of the trade deficit in 2015. Accordingly, the trade
deficit expanded to US dollars 8,430 million in 2015
from US dollars 8,287 million recorded in 2014.
Nevertheless, as a percentage of GDP, the deficit
in the trade balance declined marginally to 10.2 per
cent in 2015 from 10.4 per cent in 2014.
Earnings from exports, which grew at a
healthy rate in 2014, contracted by 5.6 per cent
in 2015 reflecting the decline across all major
export categories. The decline in international
commodity prices, the slower pace of growth in
advanced economies, geopolitical uncertainties in
many of Sri Lanka’s key export destinations, and
restrictions by the European Union (EU) on fish
imports from Sri Lanka contributed to the substantial
reduction in export earnings. Despite the significant
improvement recorded in earnings from the export of
spices (42.7 per cent) and transport equipment (60.5
per cent), the decline in earnings from tea (17.7 per
cent), rubber products (14.5 per cent), textiles and
garments (2.2 per cent), and seafood (35.5 per cent)
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
contributed to the overall decline in export earnings.
Reflecting global developments, exports to the EU
and Middle East contracted by 13.4 per cent and
11.8 per cent, respectively, while exports to the USA
increased by 2.9 per cent, on a year-on-year basis.
However, on average, export volumes increased by
4.6 per cent in 2015, while export prices, in US dollar
terms, recorded a decline of 9.8 per cent.
Although expenditure on non-fuel imports
increased significantly by 9.6 per cent during
2015, overall expenditure on imports declined
by 2.5 per cent. During the year, the fuel import
bill declined by US dollars 1.9 billion to US
dollars 2.7 billion, due to the significant reduction
in international oil prices and the lower import
volume due to less reliance on oil based thermal
power. However, the higher expenditure on the
importation of personal motor vehicles and other
consumer durables contributed largely to the
increase in expenditure on non-fuel imports. The
provision of concessionary motor vehicle permits
for government employees, reduced taxes on
the importation of motor vehicles with engine
capacity of less than 1,000cc, the depreciation of
the Japanese Yen, the availability of import credit
facilities at lower interest rates and the increase
in salaries of government employees can be cited
as reasons for the higher outlays on motor vehicle
imports. However, policy measures taken by the
Central Bank and the government towards the
end of the year resulted in a slowdown of import
expenditure on consumer goods, particularly motor
vehicles. On average, import volumes increased by
10.6 per cent in 2015, while import prices declined
by 11.8 per cent in US dollar terms.
Despite the widening of the deficit in the
merchandise trade balance and the primary
income account, the external current account
deficit in 2015 was largely unchanged from 2014,
as a result of the surpluses in the services and
secondary income accounts. The buoyancy of the
travel and tourism sub sector and the satisfactory
performance in transportation, telecommunication,
computer and information services sub sectors
contributed to the improvement of the services
account during the year. The increase in tourist
arrivals and the average period of stay and spending,
resulted in a 22.6 per cent growth in earnings from
1
tourism during the year. The continued expansion
of the Business Process Outsourcing (BPO) and
Knowledge Process Outsourcing (KPO) industries
contributed to the improved performance of the
telecommunication, computer and information
services sub sector. Meanwhile, during the year,
the deficit in the primary income account widened
further as a result of the reduction in earnings from
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
the investment of reserve assets, increased interest
payments and outflows in the form of dividends and
re-invested earnings. The slowdown in workers’
remittances and government transfers led to a
lower surplus in the secondary income account.
Workers’ remittances, which had been a traditional
source of foreign exchange, declined by 0.5 per
cent in 2015 compared to the growth of 9.5 per
cent observed in 2014. This decline can be largely
attributed to the fall in incomes of oil exporting
countries in the Middle East due to the low level of
international oil prices, and the decline in migration
under the semi-skilled and unskilled categories,
including housemaids. With these developments in
the trade, services, primary and secondary income
accounts, the current account recorded a deficit of
US dollars 2,009 million in 2015 compared to the
deficit of US dollars 1,988 million in 2014. However,
as a percentage of GDP, the current account deficit
narrowed marginally to 2.4 per cent in 2015 from
2.5 per cent a year earlier.
Both net incurrence of liabilities and net
acquisition of assets in the financial account
of the BOP were comparatively lower in 2015.
Major inflows to the financial account during the
year comprised proceeds from the issuance of two
International Sovereign Bonds (ISBs) totaling US
9

dollars 2,150 million, and the proceeds of the
international swap arrangement entered into with
the Reserve Bank of India (RBI), amounting to US
dollars 1,500 million. The inflows of FDI, portfolio
1 investment and loan inflows to the government,
banking and private sectors offered little support
to the financial account. This was partly due
to unfavourable developments in the global
economic environment and cautious investor
sentiment on the domestic front in the wake of
two major national elections. Meanwhile, the
anticipation of, and the subsequent increase of
interest rates by the US Federal Reserve prompted
foreign investors to withdraw their investments
from emerging markets. Accordingly, during the
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
year, there was a net outflow of US dollars 1,093
million from the government securities market.
Additionally, scheduled debt service payments
and the settlement of a matured ISB weighed
negatively on the financial account.
The BOP, which recorded an overall
surplus in 2014, registered a deficit in 2015
largely due to lower than expected inflows
to the financial account. In 2015, the BOP
recorded an overall deficit of US dollars 1,489
million in comparison to the surplus of US dollars
1,369 million in 2014. Consequently, Sri Lanka’s
gross official reserves declined to US dollars 7.3
Chart 1.5
4 end 2014. Meanwhile, debt service payments on
2
0.2
0
US$ billion
-2 -1.1
-4
-4.0
-6
-4.6
-8
-10
-9.7 -9.4
2011 2012
Trade Balance Current Account Balance
10
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
billion at end 2015 from US dollars 8.2 billion
at end 2014. Gross official reserves reduced
mainly due to scheduled foreign currency debt
service payments, settlement of the matured ISB,
payments to the IMF on account of the Stand-By
Arrangement (SBA) and the supply of liquidity to
the domestic foreign exchange market. The level of
gross official reserves at end 2015 was equivalent
to 4.6 months of imports of goods and 3.8 months
of imports of goods and services. Meanwhile, total
foreign assets declined from US dollars 9.9 billion
at end 2014 to US dollars 9.3 billion at end 2015,
equivalent to 5.9 months of imports of goods and
4.9 months of imports of goods and services. The
gross official reserve asset position covered 60 per
cent of the country’s short term debt and liabilities
as at end 2015.
The country’s total external debt, which
comprises external debt of the public and
private sectors, increased in 2015. The increase
in the total external debt of the country in nominal
terms was the combined outcome of a moderate
level of inflows on account of foreign loans, and
considerable outflows on account of debt service
payments throughout the year. The total external
debt stock of the country was US dollars 44.8
billion at end 2015 compared to US dollars 42.9
billion at end 2014. Further, as a percentage of
GDP, total external debt increased to 54.4 per
Balance of Payments
cent at the end of 2015, from 53.6 per cent at
1.0
1.4
Sri Lanka’s external debt obligations increased
significantly from US dollars 3,479 million in
-1.5
-2.5
-2.0
-2.0 2014 to US dollars 4,683 million, as a result of
increases in both capital and interest payments.
The increased level of debt service payments
-7.6
-8.3
-8.4
and the decline in exports of goods led to debt
2013 2014 2015 service payments as a percentage of exports of
Overall Balance
goods and services increasing significantly to 27.7
per cent in 2015 from 20.8 per cent in 2014.
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
In early September 2015, the Central Bank
decided to allow greater flexibility in the
determination of the exchange rate. Lower
than expected inflows to the current and financial
accounts, high volume of foreign exchange outflows
on account of increased imports, debt service
payments and the reversal of foreign investments
from the government securities market exerted
a substantial pressure on the domestic foreign
exchange market. In this context, the Central Bank
supplied US dollars 1.9 billion, on a net basis, to
the domestic foreign exchange market during the
first eight months of the year to curb excessive
volatilities in the exchange rate. Consequently,
the rupee depreciated marginally by 2.57 per
cent until the policy decision of the Central Bank,
on 03 September 2015, to accommodate greater
flexibility in the determination of the exchange rate.
Subsequent to this decision and till the end of the
year, the rupee recorded a depreciation of 6.64 per
cent against the US dollar, resulting in an overall
depreciation of 9.03 per cent against the US dollar
during the year. In line with the nominal depreciation
of the Sri Lankan rupee against the US dollar, and
relatively low levels of domestic inflation compared
to most trading partners, both the 5-currency and
24-currency Real Effective Exchange Rate (REER)
indices depreciated by 3.07 per cent and 2.26 per
cent, respectively, by end 2015.
Fiscal Sector Developments
Although the Interim Budget for 2015
expected a sharp reduction in the budget deficit
during the year, a number of developments
challenged fiscal management, hindering
the envisaged fiscal consolidation path. The
Interim Budget, which was presented following the
Presidential election in January 2015, introduced
several fiscal reforms aimed at realising the
expected outcomes of the fiscal consolidation
process. The government expected to reduce the
budget deficit to 4.4 per cent of GDP in 2015 from
5.7 per cent recorded in 2014, while maintaining the
central government debt to GDP ratio at 72.0 per
cent in 2015, as per the targets outlined in the
1
Medium Term Macro Fiscal Framework 2014-
2017 of the Fiscal Management Report for 2015.
Nevertheless, the fiscal sector performance
deteriorated in 2015, resulting in deviations from
the budgetary targets stipulated in the Interim
Budget for 2015. The lower than expected
collection of government revenue, high level of
recurrent expenditure, particularly on salaries
and wages, welfare expenditure, and higher than
estimated outlay on interest payments, exerted a
significant pressure on the overall budget deficit
in 2015. Accordingly, the budget deficit increased
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
from 5.7 per cent of GDP in 2014 to 7.4 per cent
of GDP in 2015, significantly overshooting the
government’s original target of 4.4 per cent of
GDP. The current account deficit, which reflects
government dissavings, increased to 2.2 per cent of
GDP in 2015 from 1.2 per cent in the previous year,
while the primary deficit, which excludes interest
payments from the overall deficit, increased to 2.9
per cent of GDP from 1.5 per cent in 2014. The
budget deficit was largely financed by domestic
sources, given the slowdown in foreign financing
during the year. The central government debt to
GDP ratio increased to 76.0 per cent in 2015 from
70.7 per cent in 2014, highlighting the need for
strong fiscal reforms to reduce the budget deficit
and accumulation of debt.
The government revenue to GDP ratio
showed an improvement in 2015, mainly
benefitting from several one off taxes and
the significant expansion in revenue from
excise duties on increased motor vehicle
imports. Although total government revenue as
a percentage of GDP increased to 13.0 per cent
in 2015 from 11.4 per cent in 2014, it remained
below the annual target of 13.3 per cent of GDP
stipulated in the Interim Budget for 2015. While
non tax revenue as a percentage of GDP declined
11
 CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

to 0.9 per cent in 2015 from 1.4 per cent in 2014, Total expenditure and net lending as a
tax revenue as a percentage of GDP increased to percentage of GDP increased to 20.5 per cent
12.1 per cent in 2015 from 10.1 per cent in 2014. in 2015 from 17.2 per cent in 2014, reflecting
Despite the increase in revenue from excise duty, a significant increase in both recurrent

1
corporate and non corporate income tax, import expenditure and public investment. During
duties, Cess levy, Special Commodity Levy
the year, recurrent expenditure as a percentage
(SCL) and Telecommunication Levy, the revenue
of GDP increased to 15.2 per cent from 12.7 per
collection from Value Added Tax (VAT) on both
cent in 2014, due to the increased expenditure
domestic activities and imports, Ports and Airports
on salaries and wages, interest payments,
Development Levy (PAL) and withholding tax
recorded a decline. The increase in tax revenue current transfers and subsidies. In nominal terms,

could also be attributed to several policy measures
introduced during the year to streamline the tax
system and expand the tax base. The key measures
introduced during the year include, the streamlining
of personal income tax by applying a lower tax
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
recurrent expenditure increased by 28.6 per cent
to Rs. 1,701.7 billion in 2015 from Rs. 1,322.9
billion in 2014, exceeding the budgetary target of
Rs. 1,552.0 billion. Salaries and wages of central
government employees increased, in nominal

rate for all employment categories, introduction
of several new taxes including few one off taxes,
and strengthening of tax administration in revenue
agencies, while taking measures to improve tax
compliance.
In nominal terms, total revenue increased
by 21.7 per cent to Rs. 1,454.9 billion in 2015
from Rs. 1,195.2 billion in 2014 mainly due to
the increase in revenue collection from excise
duties, income tax and import duties. Revenue
from excise duties became the highest single
contributor to total tax revenue in 2015, reflecting
the impact of the imposition of composite higher
excise tax rates on motor vehicles, liquor and
cigarettes. Accordingly, excise duties contributed
36.7 per cent to total tax revenue, accounting for
34.2 per cent of total revenue during the year.
Meanwhile, revenue collection from one-off taxes
terms, by 27.4 per cent to Rs. 561.7 billion in
2015, exerting a significant upward pressure on
government expenditure. Interest expenditure also
increased, in nominal terms, by 16.8 per cent to
Rs. 509.7 billion in 2015, on account of higher
borrowings and the depreciation of the rupee vis-
a-vis other foreign currencies. Meanwhile, capital
expenditure and net lending as a percentage of
GDP increased to 5.3 per cent in 2015 from 4.5
per cent in 2014. Accordingly, in nominal terms,
it increased by 24.5 per cent to Rs. 588.7 billion
during the year, in comparison to Rs. 473.0 billion
recorded in the previous year. Reflecting this
trend, public investment also increased to 5.4 per
Revenue, Expenditure and
Chart 1.6 Overall Fiscal Deficit
(as a percentage of GDP)
25

introduced during the year, such as the Super Gain 20

19.9
20.5
17.8 17.4 17.2
tax, which generated Rs. 50.0 billion, also made 15 13.6 13.1
12.2 12.0
a significant contribution to the increase in tax
11.5
10
Per cent

revenue. Although revenue from fees and charges 5

increased during the year, non tax revenue at Rs. 0

99.1 billion, recorded a decline of 31.6 per cent, -5

largely due to lower profit and dividend transfers -10

-6.2 -5.6
-5.4 -5.7
-7.4

from SOBEs and the decrease in revenue from 2011 2012 2013 2014 2015

Revenue and Grants Expenditure Overall Deficit

interest and rent.
12
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

cent of GDP in 2015 from 4.7 per cent of GDP in The total government debt to GDP ratio
2014, while in nominal terms, public investment increased to 76.0 per cent at end 2015 from
increased by 23.9 per cent to Rs. 602.8 billion in 70.7 per cent at end 2014, reflecting the weak
2015 in comparison to Rs. 486.6 billion in 2014. performance of the fiscal sector and relatively

The government mainly relied on domestic

sources of financing, particularly the non bank
low nominal GDP growth during the year. In
nominal terms, total outstanding government debt 1
increased to Rs. 8,503.2 billion at end 2015, from
sector, to fund the budget deficit of 7.4 per cent
Rs. 7,390.9 billion at end 2014. The increased level
of GDP in 2015. Net domestic financing increased
of required borrowing, as a result of the below par
from Rs. 378.7 billion in 2014 to Rs. 592.7 billion
revenue collection, and the significant depreciation
in 2015, recording a significant deviation from the
annual estimate of Rs. 208.0 billion. Of the total of the rupee against major foreign currencies
net domestic financing, 50.8 per cent, amounting largely contributed to this substantial increase in
to Rs. 300.9 billion, was raised from the non bank government debt.
sector. Meanwhile, government borrowings from
Fiscal performance in the recent past
the banking sector also increased from Rs. 126.9

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

billion in 2014 to Rs. 291.8 billion during the year, reflects serious structural weaknesses in the

which was also significantly higher than the annual government budget. The complex tax system,
estimate of Rs. 70.0 billion envisaged in the Budget relatively low revenue base, weak tax compliance
for 2015. Although borrowings from commercial as well as the need for improving tax administration
banks through Treasury bonds recorded a net adversely affect revenue generation. As reflected
repayment during the year, borrowings in the in the significant increase in the deficit in the
form of Treasury bills and Sri Lanka Development revenue account (current account) of the budget,
Bonds (SLDBs) increased. Net borrowings from the country’s revenue is not sufficient to even
the Central Bank also increased, mainly through finance the maintenance expenditure of the
Treasury bills. Despite significant outflows in government. This has forced the government to
foreign holdings of rupee denominated Treasury
recourse to borrowings even for its day-to-day
bills and Treasury bonds, net financing from foreign
operations. This structural weakness limits the
sources also increased to Rs. 236.8 billion in 2015
ability of the government to channel adequate funds
from Rs. 212.5 billion in 2014 with the issuance of
for development needs. The pressing resource
two ISBs in 2015.
needs, which tend to increase spending through
Central Government Debt borrowing, lead to a deviation of fiscal targets
Chart 1.7
(as a percentage of GDP)
from the desired levels. This leads to a vicious
60
cycle of revenue shortfalls, expenditure overruns,
50
40.9
44.3 high budget deficits, increase in government debt
38.8 40.0
37.0
40
32.3 31.7 31.7
and debt service payments, thereby lowering the
30.9 29.8
Per cent

30
expenditure on public investment and the ability to
20 enhance other essential expenditures while making
10 fiscal consolidation a difficult task. Hence, it is
0 essential to address each point of this vicious cycle
2011 2012 2013 2014 2015

Domestic Foreign
by implementing necessary reforms to revamp
budgetary operations.
13

BOX 01
Introduction
1
Generating fiscal space, to support macroeconomic
stability and improve the resilience of the economy
to face shocks, has gained the attention of fiscal
authorities across the globe, especially since the
financial crisis. Constrained fiscal environments in
both advanced and emerging market economies
have spurred interest in creating fiscal space in the
government budget, as pressures emerging from
uncertain global developments, rising debt service
obligations and demographic transitions continue
to challenge the sustainability of fiscal operations.
Budgetary processes in emerging middle income
countries, such as Sri Lanka, have come under
pressure in the light of the need for rapid development
without undue risk to the government’s future fiscal
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
position. This provokes a question as regards to the
maintenance of sufficient fiscal space in Sri Lanka.
Heller (2005) defines fiscal space as "budgetary
room that allows a government to provide resources
for a desired purpose, without jeopardising the
sustainability of its financial position or the stability
of the economy”.1 In other words, fiscal space refers
to the availability of additional resources to provide
flexibility to the government in order to decide on
its spending, revenue or borrowing choices, without
adversely impacting macroeconomic stability. Key
determinants of fiscal space include the composition
and trend of public expenditure, the propensity to
tax, the propensity to borrow and economic growth.
Therefore, fiscal space can be created by increasing
revenue, curtailing expenditure or borrowing
resources from domestic or external sources and
accelerating growth. The creation of fiscal space
should in no way compromise fiscal sustainability.
The government must ensure that it has the capacity,
in the short term and the long term, to finance its
expenditure programmes and service its debt.
Structure of Sri Lanka’s Government Budget
Competing expenditure claims in an environment of
tightening resource constraints have characterised
Sri Lankan budgetary operations in the recent past.
Pressing needs for expenditure, given the low revenue
mobilisation and tightening financial conditions, have
resulted in successive governments reporting high
budget deficits. Sri Lanka’s budget deficit for the 2010
- 2015 period averaged to around 6 per cent of GDP.
An examination of the structure of government revenue
1 Heller, P. (2005) ‘Understanding Fiscal Space’, Policy Discussion Paper PDP/05/4,
Washington, DC: Fiscal Affairs Department, IMF
14
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
Fiscal Space for Stability and Resilience
and expenditure brings forth some concerns that have
challenged fiscal authorities. Public expenditure has
been maintained on average at around 18.8 per cent
of GDP during the period 2010 – 2015. Although
the current outlays of the government hovered at
around 13.7 per cent of GDP during this period,
interest payments, the “non-discretionary” spending
component of the budget, and the expenditure on
salaries and wages have remained static in terms of
current expenditure shares, accounting for over two-
thirds of recurrent expenditure. Salaries and wages,
and interest payments have averaged 4.4 per cent
and 4.7 per cent of GDP, respectively, during 2010
– 2015. Moreover, transfer payments and welfare
expenditure of the budget, which includes transfers to
households, a key component of poverty alleviation,
have also averaged around 3.0 per cent of GDP
during this period.
In the above context, the leeway available in the
budget to accommodate other pressing needs
remains limited. The dilemma fiscal authorities face
in this context can be clearly seen when observing the
expenditure incurred by the government on priority
sectors such as education and health. An examination
of expenditure outlays on a functional basis shows
that education and health sectors receive only an
average of 16 per cent of the total funds channeled
through the budget and, on average, accounted for
1.7 per cent and 1.3 per cent of GDP, respectively,
during the period from 2010 to 2015, although there
was an improvement in 2015. An argument can be
made to increase health and education outlays, as
such expenditures will generate benefits over the
long term, by way of higher returns to human capital.
However, given the present expenditure structure of
the budget, which has limited manoeuvrability, it is
necessary for the government to create the enabling
fiscal space for this purpose.
On the revenue front, the government’s revenue
collection has been well below the total expenditure,
and not even sufficient to cover recurrent expenditure.
Revenue as a percentage of GDP averaged at around
12.4 percent during the period 2010 – 2015. The
low revenue collection is largely attributable to the
weak tax collection in the country. The tax revenue/
GDP ratio has also declined to 10.1 per cent in 2014
before picking up to 12.1 per cent in 2015, partly
due to the imposition of several one off taxes during
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

that year. Sri Lanka’s tax performance remained weak Way Forward
in comparison to its regional peers. Low elasticity
The lack of room to manoeuvre fiscal operations
of the tax system, due to numerous exemptions, tax
makes the accommodation of new demands from
avoidance and weak tax administration are some
various sectors of society, into the government
reasons for the poor revenue performance.

1
budget, an extremely difficult task. Given the inability
Revenue and Expenditure of the government to resort to additional borrowings,
Chart B 1.1 fiscal space must be created through reforms of
Performance
the tax and expenditure structures. The creation of
25
fiscal space entails a comprehensive revamp of the
20 present budgetary structure. Fiscal policy should aim
at increasing the tax/GDP ratio at least in line with
Percentage of GDP

15 that of Sri Lanka’s regional peers, by improving the

revenue mobilisation effort. Tax reforms should be
10
undertaken with a view to expanding the tax base
5 and increasing compliance. On the expenditure
front, consideration of fiscal space will have to be
0
made in the context of a medium term expenditure
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

framework, that has a comprehensive perspective on

Tax Revenue Recurrent Expenditure Salaries & Interest Expenditure the government’s expenditure priorities. At the same

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

time, the efficiency of expenditure management has to
be improved to obtain value for money in respect of
Low revenue mobilisation, together with high expenses incurred by the country. In this context, each
expenditure levels, and the associated high budget expenditure item will have to be carefully reviewed
deficits have resulted in high government debt in terms of economic, political, social and other
levels. Government debt, as a percentage of GDP, considerations of the government. Moreover, ad-hoc
has increased to 76 per cent in 2015. This has spending decisions made outside the regular budget
necessitated increased debt service payments, which should be limited as these curtail fiscal space. The
in turn have pressurised fiscal operations. Debt service government should also improve the performance
payments at present absorb about 90 per cent of the of state owned enterprises (SOEs) by improving the
revenue generated by the government through tax financial viability of these entities and reducing their
and non-tax sources. While there is not much leeway dependence on the budget. Labour market reforms
to borrow domestically from non-inflationary sources, should be undertaken to improve productivity and
high levels of external debt increase the vulnerability increase growth. The possible resistance to essential
of the country to external shocks. The lack of fiscal reforms will have to be mitigated with proper
space reflects the inability of the government to resort engagement of the government with all stakeholders,
to increase borrowings to accommodate the growing including labour associations and the general public,
resource needs of the economy. through awareness programmes.

Monetary Sector Developments Central Bank removed the restrictions placed on

the access to its Standing Deposit Facility (SDF)
The Central Bank continued to maintain an
under open market operations (OMO) that was in
accommodative monetary policy stance during
effect since September 2014. Consequent to this
the year in an environment of persistently low
measure, to address the excessive volatility of short
inflation, but initiated a gradual tightening of
term interest rates, the Central Bank lowered its key
monetary policy from end 2015 with a view to
policy interest rates, namely the Standing Deposit
preempting excessive demand pressures on
inflation, emanating from high credit and money Facility Rate (SDFR) and the Standing Lending

expansion. Considering the sustained increase in Facility Rate (SLFR), by 50 basis points to 6.00 per
credit flows to the private sector encouraged by the cent and 7.50 per cent, respectively, in April 2015.
low interest rate environment that was maintained Nevertheless, as credit and monetary aggregates
during the past few years, in March 2015, the continued to expand at a faster pace than projected,
15
 CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

the Central Bank commenced tightening monetary Rupee liquidity in the domestic money
policy gradually towards end 2015. Accordingly, market, although lower than the levels
the SRR applicable on all rupee deposit liabilities of observed in 2014, continued to be in excess
commercial banks was raised by 1.50 percentage throughout 2015. Excess liquidity remained

1 points to 7.50 per cent to be effective from the reserve

period commencing 16 January 2016, signalling the
end of the relaxation cycle of monetary policy. Even
high at the beginning of the year due to Treasury
bill purchases and provisional advances to the
government by the Central Bank. However, excess
prior to the commencement of monetary tightening, liquidity declined gradually until August 2015,
several policy measures were introduced in the last reflecting the continued supply of foreign exchange
quarter of 2015 to contain excessive credit flows to to the domestic foreign exchange market, foreign
selected sectors. Accordingly, a minimum cash margin loan repayments, early retirements and outright
requirement was imposed on Letters of Credit (LCs) sales of Treasury bills held by the Central Bank
opened for the importation of motor vehicles, which
as well as high volumes of currency issuances,
was replaced later on by a maximum Loan to Value
particularly during the general election. The Central
(LTV) ratio, a macro prudential measure, on loans
Bank managed excess liquidity in the domestic
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

and advances granted for the purpose of purchase or

utilisation of motor vehicles. These measures, along
with greater flexibility allowed in the determination
of the exchange rate and the changes to the tax
structure made by the government, were expected
to contain excessive growth of personal loans and
advances, while strengthening macroeconomic
and financial
considering the possible aggravation of demand
money market on overnight, short term and long
term bases, with a view to maintaining the stability
in short term interest rates. Nevertheless, since
September 2015, excess liquidity in the money
market increased due to the purchase of proceeds
of the Sri Lanka Development Bonds (SLDBs) by
the Central Bank, increased purchases of Treasury
system stability. Nevertheless,
bills by the Central Bank in the primary market,

driven inflationary pressures due to continued and the purchase of a part of the proceeds of the

high monetary expansion, as a preemptive policy International Sovereign Bond (ISB) by the Central
measure, the Central Bank raised its SDFR and the Bank. During 2015, overnight excess liquidity
SLFR by 50 basis points each, to 6.50 per cent and ranged from Rs. 3.3 billion to Rs. 149.6 billion,
8.00 per cent, respectively, effective from the close and averaged Rs. 76.6 billion, while total excess
of business on 19 February 2016. liquidity stood at Rs. 105.3 billion by end 2015.

Chart 1.8
Standing Rate Corridor and During the year, the Central Bank conducted
Selected Market Interest Rates
monetary policy within an enhanced monetary
15
14
policy framework with features of both monetary
13
12
targeting and flexible inflation targeting (FIT).
11
Under this enhanced monetary policy framework,
Per cent

10
9 the Central Bank attempts to stabilise inflation in
8
7 mid-single digits over the medium term, while
6
5 supporting the growth momentum of the economy.
Jun-11

Jun-12

Jun-13

Jun-14

Jun-15
Apr-11

Apr-12

Apr-13

Apr-14

Apr-15
Feb-11

Feb-12

Feb-13

Feb-14

Feb-15
Oct-11

Feb-16
Oct-12

Oct-13

Oct-14

Oct-15
Dec-10

Dec-11
Aug-11

Dec-12
Aug-12

Dec-13
Aug-13

Dec-14
Aug-14

Dec-15
Aug-15

In terms of operational aspects of this framework,

Standing Rate Corridor AWCMR (month-end) Treasury Bill Yield
(91-day)
the Central Bank uses its policy instruments to
Monthly AWPR AWDR
guide short term interest rates, particularly the
16
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

average weighted call money rate (AWCMR),
which is the operating target of the framework,
along the desired path. Reserve money is not
considered an operating target any more, although
broad money supply (M2b) remains a key indicative
intermediate variable to guide monetary policy, and
plays a key role in the annual monetary programme
of the Central Bank, which is prepared considering
the envisaged inflation target and the growth of real
GDP. However, during the year, the actual broad
money growth was substantially higher than the
projected levels.
Broad money (M2b) growth accelerated
during 2015 due to the expansion in credit to
in absolute terms, in 2015, driven by increased credit
flows to both public and private sectors. Within NDA,
net credit to the government (NCG) extended by
the banking system increased substantially by Rs.
323.6 billion, exceeding the levels envisaged in the
government budget. The considerable increase in 1
NCG is attributable to the government’s increased
reliance on domestic financing amidst delays in
the receipt of foreign financial flows, the continued
shortfall in revenue collection as well as expenditure
overruns. NCG by the Central Bank increased by Rs.
80.3 billion during 2015 with increased placements
of Treasury bills with the Central Bank, while NCG
by commercial banks increased by Rs. 243.3 billion,
due to increased investments in Treasury bills and

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

both public and private sectors. M2b increased by
SLDBs by commercial banks. However, investments
17.8 per cent, year-on-year, by end 2015 compared
in Treasury bonds by commercial banks recorded
to a growth of 13.4 per cent at end 2014, while the
a decline of Rs. 52.2 billion (net of repurchase
average broad money growth was 15.2 per cent
agreements) during the year, reflecting lesser
during the year. As net foreign assets (NFA) of the
appetite of commercial banks for long term securities.
banking system recorded a contraction during the
The outstanding overdraft balance of the government
year, the expansion in broad money was entirely
with state banks also increased by Rs. 10.5 billion to
due to the increase in net domestic assets (NDA)
Rs. 125.1 billion at end 2015 compared to Rs. 114.6
in 2015 underpinned by domestic credit expansion.
billion that was recorded at end 2014. Meanwhile, the
NFA of the banking system contracted substantially
expansion in credit obtained by public corporations
by Rs. 413.6 billion in the first ten months of 2015
from the banking sector moderated marginally to
and the contraction was moderated in the last two
Rs. 76.9 billion in 2015 in comparison to the increase
months of the year with the receipt of proceeds
of Rs. 80.9 billion observed in 2014. The increase in
from the ISB by the Central Bank. Accordingly, the
credit granted to Sri Lankan Airlines (SLA), Ceylon
contraction of NFA by end 2015 amounted to Rs.
313.3 billion. During the year, NFA of the Central Year-on-Year Growth of Broad
Chart 1.9
Money (M2b) and Private Sector Credit
Bank declined by Rs.111.8 billion along with the
increased supply of foreign exchange by the Central 40

35
Bank to the domestic foreign exchange market.
30

Meanwhile, NFA of commercial banks declined by 25

Per cent

20
Rs. 201.5 billion in 2015, with increased short term
15

foreign borrowings by commercial banks as well 10

5
as an increase of balances in non resident foreign
0
currency accounts (NRFC) and resident non
Dec-10
Mar-11
Jun-11
Sep-11
Dec-11
Mar-12
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
Jun-15
Sep-15
Dec-15

national foreign currency accounts (RNNFC). NDA

M2b Credit to the Private Sector

expanded by 26.0 per cent, or by Rs. 1,003.3 billion

17
 CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

Petroleum Corporation (CPC), Road Development Credit as a Ratio of

Chart 1.10
Authority (RDA) and Paddy Marketing Board (PMB) GDP and Deposits
60 140
mainly contributed to the expansion in credit to
50 120
public corporations during the year, while Ceylon

1
100
40
Electricity Board, Ceylon Fertiliser Corporation and 80

Per cent

Per cent
30
Colombo Commercial Fertiliser repaid a part of 60
20
their outstanding liabilities to the banking sector. 40

10 20

In response to the continued relaxed 0 0

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
monetary policy stance, credit extended to
Private Sector Credit to GDP Ratio (%) - (Left Axis) Domestic Credit to GDP Ratio (%) - (Left Axis)

the private sector by the banking system Domestic Credit to Deposit Ratio (%) - (Right Axis)

expanded at a high rate. By end 2015, credit to

the private sector increased by 25.1 per cent on a the Industry sector expanded significantly by 34.1
year on year basis, compared to the 8.8 per cent per cent and 25.0 per cent, respectively, indicating
growth recorded at end 2014. In absolute terms, the continued flow of credit to major sectors of the
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

credit to the private sector increased by Rs. 691.4
billion during the year compared to the increase of
Rs. 223.9 billion in 2014. The acceleration of
credit extended to the private sector was driven
by persistently low market lending rates as well as
the aggressive marketing campaigns by lending
institutions to attract borrowers. In addition to the
regular expansion in private sector credit, this
included an additional sum of Rs. 83.0 billion of
loans and advances that was added to the overall
expansion in credit to the private sector in M2b, as
a result of the merger of DFCC Vardhana Bank
and DFCC PLC in October 2015 to formulate one
licensed commercial bank. Meanwhile, as per the
Security-wise Analysis of Advances, credit in terms
of leasing and hire purchase agreements increased
considerably by Rs. 65.6 billion in 2015 compared
to the increase of Rs.16.4 billion in the previous
year, indicating high import demand for motor
vehicles. The contraction in pawning advances
was limited to Rs. 38.2 billion in 2015 compared to
the significant decline of Rs.140.0 billion recorded
in 2014. Moreover, as per the Quarterly Survey of
Commercial Banks’ Loans and Advances to the
Private Sector, credit to the Services sector and
18
economy during the year.
Market interest rates remained low during
2015 although some upward movement was
observed during the latter part of the year.
AWCMR, which had remained below the SDFR
since September 2014, due to the restrictions
placed on SDF, moved upward in March 2015
consequent to the removal of the restrictions.
Although AWCMR declined with the reduction in
policy interest rates in April 2015 and remained
close to the lower bound of the policy rate
corridor until August 2015, it displayed some
upward trend thereafter. This movement in
AWCMR was mainly a reflection of the decline
in excess liquidity in the domestic money market.
Accordingly, AWCMR was at 6.40 per cent by end
2015 in comparison to 6.21 per cent at end 2014.
Meanwhile, yields on government securities also
increased substantially during 2015. Although
the issuances of SLDBs and ISB helped ease
the pressure on interest rates on domestic debt
instruments to some extent, market anticipation
of a high domestic funding requirement of the
government amidst delays in foreign financial
inflows and the Central Bank’s decision to issue
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
government securities only through public
auctions increased pressure on the yields on
government securities. Meanwhile, interest
rates offered on deposits by commercial banks
remained low during 2015, although a gradual
increase was observed since the middle of
the year. By end 2015, the average weighted
deposit rate (AWDR) stood at 6.20 per cent,
having returned to the same level that prevailed
at end 2014. The average weighted fixed
deposit rate (AWFDR) increased by 24 basis
points to 7.57 per cent by end 2015 from 7.33 per
cent at end 2014. The average weighted lending
rate (AWLR), which captures lending rates on
all advances weighted by outstanding loan
balances, declined by 91 basis points to 11.00
per cent by end 2015 from 11.91 per cent at end
2014. Nevertheless, reflecting the gradual rise in
short term lending rates towards the latter part
of the year, the weekly average weighted prime
lending rate (AWPR) increased by 127 basis
points to 7.53 per cent by end 2015 from 6.26 per
cent at end 2014. The increasing trend in interest
rates continued into the first quarter of 2016,
mainly reflecting the monetary policy tightening
measures adopted by the Central Bank, reduced
levels of excess liquidity in the money market, and
the continued high financing requirement of the
government.
Financial Sector Developments
In 2015, the financial sector demonstrated
its resilience to volatile market conditions
emanating from domestic and global
uncertainties. Business operations of the banking
sector expanded, supported by increased credit
demand against the backdrop of the low interest
rate regime, increased profits and internal capital
generation, which augmented the cushion
available in the sector for absorbing risks arising
from any adverse shocks. Asset quality of the
banking sector improved during the year. The
finance and leasing companies sector also
recorded improved performance as reflected in its
increased relative share in terms of total assets of
the domestic financial system. The Central Bank
continued to take regulatory measures in 2015
1
to protect depositors’ and investors’ interest in a
few liquidity threatened finance companies. The
Primary Dealers of government securities showed
moderate operating results in spite of rapid business
expansion, while the liquidity issues faced by one
primary dealer necessitated regulatory intervention
to maintain investor confidence and facilitate
smooth operations in the government securities
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
market. Contractual savings institutions secured a
return close to levels in previous years in spite of low
market interest rates. Other non-banking financial
institutions also recorded business growth, but with
mixed operating performances given their business
models and financial market conditions. During the
year, domestic financial markets operated with
relatively high volatility consequent to monetary
and BOP conditions that emanated partly from
global developments. Meanwhile, large and retail
value national payments systems of the country
operated smoothly without any major disruption
and stability concerns, while facilitating the growing
and changing payment needs of the financial sector
and the general public, with improved efficiency
and safety.
Introducing regulatory measures to
strengthen liquidity risk management of banks
and credit risk management of banks and non-
banking financial institutions, and taking action
to curb unauthorised finance businesses were
the key developments in the licensed bank
and non-bank financial sector with regard to
new prudential regulations. Further, with a
view to promoting electronic payments among
the general public, limits were imposed on
transaction fees charged by banks from their
19

customers on large value and retail electronic
fund transfers. The implementation of several
regulations for the insurance industry in areas of
settling insurance claims within a stipulated time
1 period to protect claimants, imposing a minimum
net capital level for insurance brokers to enhance
soundness, streamlining business canvassed by
insurance agents for customer protection, and the
requirement for all insurance companies to adhere
to risk based solvency margin (risk based capital)
to enhance risk management systems of insurance
companies, were seen in 2015. The formulation
of a capital market development master plan
covering statutory gaps, risk management, and
public awareness, and the adoption of the Global
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
Industry Classification Standard (GICS) to classify
companies listed in the Colombo Stock Exchange
(CSE) were other major policies to develop listed
debt and equity capital and unit trust markets.
1.3 Global Economic Environment
and Outlook
According to the World Economic Outlook
of the International Monetary Fund (IMF),
global economic activity remained subdued in
2015, with the decline in growth in emerging
market and developing economies, amidst the
modest recovery in advanced economies. The
performance of a number of advanced economies
and their emerging market counterparts diverged
as output gaps narrowed in certain advanced
economies while emerging markets encountered
new challenges during the year. These were
mainly a result of rebalancing of economic
activities in key emerging markets and low levels
of commodity prices. The persistent decline in oil
prices helped maintain inflation at subdued levels
in most economies although oil exporting countries
experienced shrinking fiscal and external spaces.
Weak growth prospects, worsening terms of
20
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
trade and spillover effects of the monetary policy
tightening by the Federal Reserve of the United
States (US) led to several currencies facing
depreciation pressures during the year.
Global growth is expected to
dampened, weighed down by the performance
remain
of large emerging market economies.
Accordingly, global growth is estimated at 3.2 per
cent in 2016 and 3.5 per cent in 2017. Despite
challenges posed by the global environment,
the Federal Reserve expects the US economy
to continue expanding at a moderate pace as a
result of the increase in household spending and
strengthening of the labour market. The robust
economic recovery of the United Kingdom (UK) has
been driven by the accommodative monetary policy
of the Bank of England and the resultant expansion
of private domestic demand, helping to offset
the contractionary impact of fiscal consolidation.
However, there are concerns that the positive
outlook of the UK economy may be impacted by
the uncertainty surrounding the referendum on EU
membership scheduled for mid-2016. The growth
prospects of advanced economies are weighed
down by the downgraded economic outlook for
Japan where inflation expectations remained weak.
In addition, lower than expected levels of inflation
could weigh negatively on the performance of
the euro zone in 2016. While recent reductions
in key interest rates and expansion of bond
purchases by the European Central Bank may help
tackle the deteriorating inflation outlook, political
developments, such as volatilities associated
with terrorism, and the surge of refugees from the
Middle East and Africa, may cap the growth outlook
for the region. Among emerging market economies,
rebalancing of China’s growth strategy, from one
driven by investment to one driven by domestic
consumption, is expected to have far reaching
implications. In the short run, this transformation
is expected to generate spillover effects through
trade and financial channels. Meanwhile, a low
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

inflation environment, substantial FDI flows and
preemptive supply side measures are expected to
help India sustain its growth in the coming years,
complemented by strong domestic demand and
a boost in private investment.
exchange markets. While it may be expected that
net commodity importers would have benefited
from the low commodity prices, linkages between
net exporters and net importers caused savings

The decline in commodity prices throughout

2015 presented several challenges to the pace
of recovery of the global economy. The recent
fall in international commodity prices extended
across all commodity sectors, including energy,
metals and minerals, and agriculture. In general,
net commodity exporting economies experienced
lower economic growth prospects, currency
depreciation, decline in export revenues and
from price declines to be negated by lower inflows
in terms of remittances, tourism earnings, capital
flows and even foreign aid.
1
The volatility of the global economic
environment posed several challenges to Sri
Lanka during 2015 and these are expected
to persist in 2016. With the continued decline
in global oil prices, the stagnating growth in
Middle Eastern countries negatively affected
workers’ remittances and tea exports, which

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

a deterioration of the current account. These are key sources of foreign exchange. This trend
economies responded to currency depreciation is expected to continue to impact remittances
and capital outflows through tighter monetary and future job prospects of Sri Lankan migrant
policies and increased intervention in foreign workers. Further, the stagnating growth momentum
of economies, which have been Sri Lanka’s
Global Economic Developments
Table 1.4 traditional sources of tourism, e.g. Europe, Russia
and Outlook (a)
and China, may cause a decline in tourist earnings
2016 2017
Item 2014 2015
(Proj) (Proj) in the coming year, despite the significant growth
World Output 3.4 3.1 3.2 3.5 observed in 2015. During the year, as observed
Advanced Economies 1.8 1.9 1.9 2.0
United States 2.4 2.4 2.4 2.5
across all emerging markets, there was a significant
Euro Area 0.9 1.6 1.5 1.6 unwinding of investments from the domestic
United Kingdom 2.9 2.2 1.9 2.2
Japan 0.0 0.5 0.5 -0.1 government securities market, on expectations
Emerging and Developing Economies 4.6 4.0 4.1 4.6 of the monetary policy normalisation of the US
Developing Asia 6.8 6.6 6.4 6.3
China 7.3 6.9 6.5 6.2 Federal Reserve. Subsequent to the interest rate
India 7.3 7.3 7.5 7.5
hike in December 2015 by the Federal Reserve
World Trade Volume 3.4 2.8 3.1 3.8
(Goods and Services) and on expectations of further hikes in 2016, it is
Imports
expected that this trend will continue. In addition,
Advanced Economies 3.4 4.3 3.4 4.1
Emerging and Developing Economies 3.7 0.5 3.0 3.7 Sri Lanka may have to incur higher levels of interest
Exports
Advanced Economies 3.4 3.4 2.5 3.5
payments on foreign loans that had been obtained
Emerging and Developing Economies 2.9 1.7 3.8 3.9 on a variable rate basis by the government, state
Price Movements
Consumer Prices
owned enterprises (SOEs) and the private sector.
Advanced Economies 1.4 0.3 0.7 1.5 Global uncertainties caused by factors such as the
Emerging and Developing Economies 5.1 4.7 4.5 4.2
Commodity Prices (US$) weakened pace of global economic growth and
Oil -7.5 -47.2 -31.6 17.9
geopolitical developments may affect FDIs to the
Non-Fuel -4.0 -17.5 -9.4 -0.7
Six-month London Interbank Offered country, both directly and through spillover effects,
Rate (LIBOR) on US$ Deposits (per cent) 0.3 0.5 0.9 1.5
particularly from China and its major commodity
(a) Annual percentage change Source: World Economic Outlook
unless otherwise indicated. (April 2016), IMF
trading partner countries, and from the Middle East.
21

1.4 Medium Term Macroeconomic
Outlook
Sri Lanka’s economy is projected to expand
1 at a rate of 5.8 per cent in 2016, and strengthen
over the medium term to achieve a higher
growth trajectory of around 7 per cent. The
envisaged growth path is expected to be attained
with the improvement in investor sentiments. Further,
the new policy initiatives of the government to spur
growth across all major sectors of the economy and
increase private sector participation through the
creation of an investor friendly environment, are also
expected to contribute to the growth trajectory of the
economy over the medium term. The implementation
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
of policy measures to encourage small and large
scale entrepreneurs to participate in the global
economy and the resultant positioning of Sri Lanka
in the global value chain, are expected to bolster the
contribution of the Industry, Agriculture and Service
sectors to this growth momentum. Accordingly,
the growth potential of the economy is expected to
be enhanced through the adoption of advanced
technology and the subsequent digitisation of the
economy, attraction of new investment initiatives,
including those of global tech giants, and the effective
utilisation of socioeconomic infrastructure facilities.
It is also expected that the gradual recovery of the
global economy will provide the required impetus to
maintain Sri Lanka’s external demand at favourable
levels. However, the rise in income levels, expected
from this improved external demand, will support Sri
Lanka’s graduation to the upper middle income status,
bringing forth new challenges, as characterised by
the ‘middle income trap.’ Appropriate monetary and
fiscal policy measures are expected to create an
environment conducive for investment. Accordingly,
inflation is estimated to be at a low level of around
4.0 per cent. Meanwhile, fiscal policy will continue
to focus on strengthening the fiscal consolidation
process.
22
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
Positive developments in the domestic and
global economies, coupled with recent policy
initiatives, are expected to result in a favorable
outlook for the external sector over the medium
term. The decline in the current account deficit is
expected to be largely driven by the improvement in
trade in merchandise goods and services. Although
import expenditure is expected to decline in 2016, as
a result of the low level of international oil prices and
the decline in motor vehicle imports as a result of the
greater flexibility in the determination of exchange
rates, it is expected to rise thereafter with the
anticipated increase of crude oil prices in international
markets and the growth in imports of investment goods
required to facilitate the new growth trajectory. Exports,
which recorded a decline in 2015, are expected to
regain their upward momentum over the medium
term with the expected recovery of global demand
and the improvement in external competitiveness,
induced by productivity improvements. Meanwhile,
earnings from trade in services are expected to
record a gradual improvement with the realisation
of the outcomes of policy initiatives to position Sri
Lanka in the global value chain. However, workers’
remittances are expected to slow down due to the
decline in migration for foreign employment as a
result of economic and geopolitical uncertainties
in traditional destinations, such as the Middle East
and Europe, the increased availability of domestic
employment opportunities, and the implementation
of policy measures to discourage migration in
semi-skilled and unskilled categories. The overall
BOP position is also expected to improve over the
medium term, with the expected rise in inflows to the
financial account. Several policy measures adopted
by the government, including the establishment of
a ‘one-stop-shop’ by the Board of Investment to
create a hassle-free environment for investors, are
expected to attract a substantial level of FDIs. The
envisaged improvements in the BOP are expected
to thereby strengthen external reserves, enabling
the country to improve its resilience to external
shocks.
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

The medium term fiscal strategy of the
government will focus on strengthening the
fiscal consolidation process, by maintaining the
budget deficit and public debt at a sustainable
level, conducive to the broad based development
objective of enhancing the living standards of
the people. The policy measures proposed by the
government to enhance revenue and rationalise
expenditure are expected to facilitate the fiscal
consolidation process in the medium term. As stipulated
in the Fiscal Management (Responsibility) Act No. 3 of
2003, as amended, and the announcement made by
the government in November 2015, the budget deficit
is expected to be reduced to 3.5 per cent of GDP by
2020, while the debt to GDP ratio is to be reduced
System (RAMIS) at the Inland Revenue Department
(IRD), the ‘Single Window’ at the Sri Lanka Customs
(SLC) and the Integrated Treasury Management
Information System (ITMIS) at the General Treasury
is expected to result in substantial improvements
in the revenue administration process. In order to
complement the ongoing fiscal consolidation process,
1
certain measures, including the establishment of a
Budget Implementation and Monitoring Unit (BIMU)
in the Department of National Budget in the Ministry
of Finance, were introduced for the rationalisation
of public expenditure and the maintenance of public
investment at a sustainable level. On the expenditure
front, the government’s commitment towards the
rationalisation of government expenditure and the

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

to 60.0 per cent over this period. On the revenue
front, a simplified tax regime, broadened tax base,
enhanced tax compliance and improvements in the
tax administration are expected to increase revenue
mobilisation. Meanwhile, the implementation of the
Revenue Administration Management Information
curtailment of unproductive expenditure, are expected
to limit recurrent expenditure to below 15.0 per cent of
GDP over the medium term. Accordingly, the current
account balance, which reflects the savings position
of the government, is expected to gradually improve
over the medium term on a sustainable path.

Table 1.5 Medium Term Macroeconomic Framework (a)

Projections
Indicator Unit 2014 (b) 2015 (c)
2016 2017 2018 2019
Real Sector
Real GDP Growth (d) % 4.9 (c) 4.8 5.8 6.3 7.0 7.0
GDP at Market Price (d) Rs. bn 10,448 (c) 11,183 12,307 13,614 15,155 16,863
Annual Average Inflation % 3.3 (c) 0.9 4.0 4.0 4.0 4.0
Per Capita GDP (d) US$ 3,853 (c) 3,924 4,008 4,298 4,704 5,181
Total Investment (d) % of GDP 32.0 (c) 30.1 30.3 30.9 31.0 32.0
Domestic Savings (d) % of GDP 24.0 (c) 22.6 23.8 24.6 25.3 26.7
National Savings (d) % of GDP 29.5 (c) 27.8 28.1 29.1 29.5 30.6

External Sector
Trade Gap (d) % of GDP -10.4 -10.2 -9.5 -9.7 -9.7 -9.6
Exports US$ mn 11,130 10,505 10,853 11,542 12,057 12,589
Imports US$ mn 19,417 18,935 18,920 20,500 21,940 23,387
Current Account Balance (d) % of GDP -2.5 -2.4 -2.1 -1.8 -1.5 -1.4
External Official Reserves Months of Imports 5.1 4.6 4.0 4.2 4.5 4.6

Fiscal Sector (e)

Total Revenue and Grants % of GDP 11.5 13.1 12.7 13.5 13.9 14.9
Expenditure and Net Lending % of GDP 17.2 20.5 18.0 18.5 18.4 18.9
Current Account Balance % of GDP -1.2 -2.2 -1.4 -0.7 0.0 0.6
Overall Budget Deficit % of GDP -5.7 -7.4 -5.4 -5.0 -4.5 -4.0
Central Government Debt % of GDP 70.7 76.0 74.0 70.0 66.0 63.0

Monetary Sector (f)

Broad Money Growth (M2b) % 13.4 17.8 9.0 10.5 11.5 11.5
Growth in Credit to the Private Sector % 8.8 25.1 12.0 11.0 11.5 12.0
(a) Based on information available by mid March 2016. Sources: Department of Census and Statistics
(b) Revised Ministry of Finance
(c) Provisional Central Bank of Sri Lanka
(d) The data is based on the base year 2010 GDP estimates of the Department of Census and Statistics.
(e) Medium term fiscal indicators are based on the revised numbers for 2016 by the Ministry of Finance.
(f) Year-on-year growth based on end year values.

23

The conduct of monetary policy in the medium
term will focus on maintaining inflation in mid-
single digit levels while facilitating the economy
to realise its potential. In this pursuit, the Central
1
Bank would conduct its monetary policy within an
enhanced monetary policy framework, aligned
towards a flexible inflation targeting (FIT) framework,
which focuses on both price stability and economic
stability. The AWCMR would be the operating target
under this enhanced monetary policy framework, and
greater emphasis would be placed on market based
instruments, particularly policy interest rates and
OMO, to guide the AWCMR along the desired path
to maintain inflation within the targeted levels. Broad
money supply would continue to be a key indicative
intermediate variable to guide monetary policy.
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
Accordingly, the annual monetary programme of the
Central Bank, which takes into account the growth in
broad money supply, would be prepared in line with
the anticipated growth of nominal GDP. Meanwhile,
the robust growth in credit and monetary aggregates
that was observed in 2015 is expected to moderate
in the medium term supported by appropriate policy
measures, thus ensuring that inflation remains at the
envisaged mid-single digit levels. While focusing on
the achievement of inflation objectives, the Central
Bank would ensure sufficient availability of credit in
the economy to facilitate the economy’s transition
towards a high growth trajectory. Credit extended to
the government by the banking sector is expected to
decline in line with government’s efforts to strengthen
the fiscal consolidation process, thereby releasing
additional resources for more productive private
investments. Foreign assets of the banking system
are also expected to improve in the medium term,
with the realisation of expected higher inflows to the
financial account of the BOP.
1.5 Issues and Policies
Improving fiscal performance through
essential reforms is key to achieving the
envisaged medium term fiscal consolidation
path, reducing public debt, and strengthening
24
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
prospects for a brighter macroeconomic
outlook. This should encompass enhancing
government revenue, improving the management
of government expenditure and implementing
other reforms, particularly in state owned
enterprises (SOEs), while improving public
financial management. Despite efforts made
by successive governments towards fiscal
consolidation, government revenue, particularly
tax revenue as a percentage of GDP, has declined
over the past several years, although it increased
in 2015 mainly due to the introduction of one-off
taxes and increased revenue from excise duties on
motor vehicle imports. This was largely due to tax
evasion and avoidance, excessive tax concessions
and exemptions, ad hoc revenue measures taken
from time to time and weaknesses in revenue
administration. Therefore, in order to reverse the
declining trend in the revenue to GDP ratio on a
sustainable basis, and to improve the elasticity
of the tax system, the tax structure of the country
needs further rationalisation. Towards this end,
the government needs to focus on simplifying the
tax structure, broadening the tax base, increasing
tax compliance, minimising tax exemptions and
concessions, making the tax system equitable,
while strengthening tax administration. In
particular, income tax collection needs to be further
strengthened as the government policy is aimed
at improving the ratio of direct to indirect taxes. At
the same time, a critical assessment on various
aspects of tax laws is also necessary to identify
their weaknesses as well as complexities, to
bring about necessary improvements to the legal
framework to complement the ongoing process
of redrafting tax laws. The relative overreliance
on import related taxes has made the country’s
fiscal system vulnerable to the external sector
performance, which needs to be taken into account
in efforts on designing the country’s tax policy.
Such restructuring must also facilitate protecting
the country’s external competitiveness. While the
government’s initiatives to implement an automated
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
tax administration system, including the Revenue
Administration Management Information System
(RAMIS) of the Department of Inland Revenue
is commendable, more efforts are required to
improve the tax compliance of both corporate
and non-corporate sectors. The simplification
of the tax system as well as expediting dispute
resolution mechanisms would also improve the
Doing Business ranking of Sri Lanka, in addition
to their positive effect on revenue generation. On
the expenditure front, the government needs to
improve the quality of its spending programmes
by curtailing unproductive expenditure, while also
assessing the sustainability of existing subsidy
schemes to provide necessary support for the
needy segments of the population. Overruns in
recurrent expenditure could limit the availability of
resources for public investment, thereby affecting
the growth prospects of the country. Further, in
an environment of high government debt, a large
part of financial resources has to be allocated
for debt repayment and interest payments,
significantly reducing the country’s fiscal space
for growth promoting activities and sustenance
of essential welfare services. High budget deficit
crowds out private sector investments, while
expansionary financing poses challenges for
monetary management and maintaining exchange
rate stability. Therefore, urgent steps are needed to
strengthen fiscal consolidation efforts.
An equally important issue is the
unavoidable reforms in SOEs, which should
be undertaken based on a carefully thought
strategy and implemented within the country’s
socio-economic and political context, while
adequately explaining and educating the
stakeholders and the general public on the
rationale and potential medium to long-term
consequences in the absence of such reforms.
Over the years, many SOEs have continued to
make losses due to a number of reasons, including
absence of cost-reflective pricing mechanisms,
weak financial management, lack of good
governance, weaknesses in human resource
management, lack of internal controls, structural
deficiencies, and political interference. The
significant amount of accumulated losses of SOEs
are particularly of serious concern as they continue
to be a major drag on the economic prospects of
1
the country. Proper identification of the issues and
causes for these losses, careful reviewing of the
available options to revive the respective entities,
identification of needs, including cost reflective
pricing strategies, management and marketing
expertise, proper controls, recapitalisation, etc.,
following a pragmatic strategy are important to
improve the financial viability of SOEs.
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
Maintaining the resilience of the external
sector against various shocks will require a
concerted effort to overcome the challenge
of attracting more non-debt creating foreign
investment flows such as FDI and growth
promoting long term financial flows. Despite
the improvements marked in recent years, Sri
Lanka has persistently maintained a deficit in the
external current account, thus necessitating the
use of debt creating financial flows or the use of
foreign exchange reserves to finance the deficit. As
Sri Lanka is undergoing a demographic transition
with a rise in the elderly dependency ratio, public
expenditure on this category of the population
will rise, thereby weighing negatively on public
sector savings. In addition, private sector savings
could remain depressed unless the productivity
of the existing labour force and corporate savings
are raised. Hence, the savings-investment gap,
which is identical to the current account deficit,
will further deteriorate and the gap will have to
be financed through foreign sources. Economic
and geo-political developments around the world
have proven that the country cannot entirely rely
on workers’ remittances and external borrowings
to finance the current account deficit, as these are
susceptible to economic and political volatilities in
25

source countries, as was evident from the sharp
moderation in remittance flows in 2015 in the
wake of low oil prices and prevailing unrest in the
Middle Eastern region. Although Sri Lanka had
1 been successful in drawing loans from multilateral
agencies on concessional terms, access to
concessional funding will diminish in Sri Lanka’s
transition towards a higher middle-income country.
Further, the ongoing monetary policy normalisation
in advanced economies will translate into increased
cost of new borrowing. Therefore, priority should
be given to the implementation of policies to attract
FDI and other long term private sector flows over
the coming years, through efficient business
facilitation, investment promotional activities in key
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
potential markets overseas and prompt availability
of information on investment opportunities. While
the relaxation of exchange control regulations,
strengthened macroeconomic environment as
well as greater political stability in the country will
make investment environment more attractive,
further steps need to be taken to encourage foreign
investments. Executing the required reforms to
improve the Doing Business ranking is necessary
to boost the investment climate and realise the full
growth potential of the economy. In addition to
healthy economic indicators such as high growth
and low and stable inflation, good governance
and guarantee of property rights, including land
ownership, would also enhance investor confidence
in the domestic economy. Further, due attention is
required in order to avoid policy inconsistencies
such as uncertainty in legislation on property rights,
inconsistent and regressive tax policies, and weak
rule of law and enforcement mechanisms that could
discourage foreign investments.
Strengthening the external sector resilience
would largely depend on the performance
of external trade both in goods and services,
backed by enhanced competitiveness. Sri
Lanka has been continuously burdened with a
significantly high trade deficit due to low growth
26
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
in exports, compared to the growth in imports.
Despite the increase in Sri Lanka’s merchandise
exports in nominal terms, as a percentage of
GDP, exports declined from 33.3 per cent in
2000 to 12.8 per cent in 2015, while the share in
global exports also contracted in a similar manner,
indicating that the country’s exports are becoming
less competitive compared to the other competing
countries. Hence, improving the country’s external
competitiveness is imperative for narrowing
the external trade deficit. As a country with a
limited resource base, small domestic market
and investment capacity, Sri Lanka should focus
on export-led strategies. Insufficient investment
in research and development, non-existence of
financing especially for exports, insufficient market
promotion, low quantum of assistance for SMEs
for trade fair participation and market development
programmes, lower productivity due to the dearth
of skilled labour and high cost of energy are the
common issues that erode the competitiveness
of Sri Lankan products in international markets.
Additionally, the concentration of export products
and market destinations is another concern as it
can lead to instability in export earnings. Apart
from maintaining a competitive exchange rate, a
public and private sector combined multi-faceted
approach is essential for moving export industries
up the value chain. In this respect, the possibility of
integrating industries with high export potential that
enjoy a comparative advantage into global value
chains should be explored and encouraged while
promoting FDIs and other investors in those sectors.
Therefore, Sri Lanka should promote competitive
industries while attracting foreign investors who
would not only bring in capital but also modern
technology, management skills, technical expertise
and assured markets.
For enhanced market access and product
diversification, existing trade agreements and
arrangements for trade facilitation must be
optimally utilised. Sri Lanka is mostly dependent
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
on European and USA markets, which account
for around two third of total exports and the
continued reliance on traditional export markets
makes Sri Lanka vulnerable to external shocks.
In recent years, regional trade agreements (RTA)
have become prominent in the global trade to
reinforce and enhance international trade, mainly
through mutual reduction in trade barriers. Sri
Lanka is also a signatory to bilateral & multilateral
trade agreements, mostly with a regional focus.
However, it has lagged behind with only four
preferential trade agreements (PTAs) in force. In
order to exploit large economies as potential export
markets, a free-trade agreement (FTA) with China
is being explored, which, however, needs careful
drafting so as to effectively enhance export trade
with China, thereby reducing the trade gap with
China. Studies have revealed that the success
of South Asian RTAs is limited as a result of low
level of tariff concessions, negative lists, non-tariff
barriers (NTB), phase-down approach, similarities
in production structure and consumption pattern,
and illegal trade. NTBs varying from port
restrictions, rules of origin related issues, quota
restrictions, import licensing requirements, labelling
requirements, and costs and delays related to
technical compliance have created impediments to
reap the potential benefits offered by the India-Sri
Lanka Free Trade Agreement (ISFTA) as well. Such
problems have made the exporters lose confidence
in FTAs. However, given its size and the growing
Indian market, with huge untapped potential for Sri
Lankan exporters, appropriate measures should be
taken to resolve some of the NTBs. In this regard, it
will be beneficial to consider the Mutual Recognition
Agreement (MRA) on Conformity Assessment
Procedures (CAPs) to minimise barriers faced at
the Indian ports, while taking measures to build
capacity to ensure exporters meet international/
importing country standards, cost effectively. At the
same time, bilateral negotiations with India should
be continued, particularly on easing NTBs, while
effectively disseminating information to the involved
stakeholders. It is also envisaged that Sri Lanka
will benefit from multilateral free trade agreements
(MFTAs) that would increase its participation in
global production value chains. In this respect,
entering into economic partnerships or FTAs with
some of the main players in the Asian supply chain,
such as South Korea, Japan, Singapore, Malaysia,
1
would be fruitful, while such agreements with the
main export destinations outside Asia too need
to be pursued to enhance trade. Also, it would
be worthwhile to evaluate the impact of being a
signatory to the WTO Information Technology
Agreement (ITA) in the wake of Sri Lanka’s pursuit
of increasing exports of IT products. Further,
the absence of PTAs with some of Sri Lanka’s
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
potential markets, where Sri Lanka’s competitors
have access under preferential tariff schemes, is
another concern. This has resulted in our exporters
having to compete without a level playing field in
the international market, which has put Sri Lanka
in a disadvantageous position. Initiation and
capitalisation on FTAs and PTAs in order to increase
market access would yield Sri Lanka a competitive
advantage amongst competitors, while integrating
into the international markets. Meanwhile, efforts
to regain the Generalised System of Preference
plus (GSP+) concession and to get the ban on fish
exports to the EU lifted need to be expedited.
Despite continued public investment in
socioeconomic infrastructure, development
challenges arising from the country’s transition
into a middle income economy have to be
tackled through proactive policies, which are
properly targeted and centred on creating an
inclusive growth. When compared to its peers
in the region and other lower middle income
economies, Sri Lanka had been a forerunner in
the fulfilment of many of the goals set out in the
Millennium Development Goals (MDGs), some of
which had been achieved well before the target
year of 2015. Nevertheless, studies show that
certain regions of the country and pockets of the
27

The Socioeconomic Challenges of Poverty, Income Inequality and
BOX 02
Child Under-nutrition in Sri Lanka
Since independence, Sri Lanka has gradually evolved
from a low income, predominantly agricultural
1
economy, to a more diversified, service oriented,
lower middle income economy by now. This economic
transformation has been complemented by many
notable developments, especially in the area of social
development, such as education and health. Although
Sri Lanka has been a success story in development
policy circles, the ongoing socioeconomic
transformation has given rise to concerns with respect
to the sustenance of such developments, especially
in the areas of poverty, income inequality and child
under-nutrition. While various challenges persist
across all spheres of the economy, studies show that
the issues of poverty, income inequality, and child
under-nutrition can severely undermine economic
growth and result in social unrest. Therefore,
addressing challenges in these three particular areas
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
is necessary to improve the living standards of the
people and achieve sustainable economic growth
and development.
Poverty
“Don’t ask me what poverty is because you
have met it outside my house. Look at the
house and count the number of holes. Look
at my utensils and the clothes that I am
wearing. Look at everything and write what
you see. What you see is poverty”.
- A poor man, Kenya 1997 1
Poverty is generally defined as whether households
or individuals have enough resources or abilities to
meet their needs. The multidimensional nature of
deprivation associated with poverty and the notion of
the existence of poverty amid plenty has resulted in
poverty reduction consistently being at the forefront
of the global development agenda.
Sri Lanka has made notable strides in reducing
poverty, enabling the country to achieve the target
set out in the Millennium Development Goals (MDGs)
of halving poverty at the national level seven years
before the deadline of 2015. Under the commonly
used measure, the Poverty Headcount Ratio (PHCR),
which presents the total number of persons living
below the poverty line2 as a percentage of the total
population, Sri Lanka’s poverty declined to 6.7 per
cent in 2012/13, from 8.9 per cent in 2009/10 and
1 “Can Anyone Hear Us? Voices From 47 Countries”, Deepa Narayan with Raj Patel, Kai
Schafft, Anne Rademacher and Sarah Koch-Schulte, Poverty Group, PREM, World Bank,
December 1999, p.26.
2 Sri Lanka’s official national poverty line defines a person as being poor in the 2012/13
Household Income and Expenditure Survey (HIES) if his or her real per capita consumption
expenditure is less than Rs. 3,624 per month, which is equivalent to about US dollars 1.50
in 2005 purchasing power parity terms. Data from the HIES, conducted by Department of
Census and Statistics (DCS), once in three years, is used to calculate poverty using the Cost
of Basic Needs (CBN) method. The latest HIES is for 2012/13.
28
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
28.8 per cent in 1995/96. In terms of the PHCR, in
2012/13, approximately 1.3 million individuals were
in poverty, in comparison to 1.8 million in 2009/10.
According to a World Bank report, which uses an
extreme poverty line of US dollars 1.25 per person
per day (in 2005 purchasing power parity (PPP) terms)
for comparison purposes, Sri Lanka’s poverty is low
by international standards.3 Under this definition,
extreme poverty in Sri Lanka fell from 13 per cent in
2002 to around 3 per cent in 2012/13.
This significant decline in poverty is the outcome
of various programmes implemented by successive
governments, to raise the income levels of vulnerable
sections of the population, especially those living
below the poverty line. These include direct financial
assistance, livelihood support programmes,
empowerment programmes to encourage village
and community centric economic activities, subsidy
programmes generally directed towards low income
people, food assistance programmes and general
welfare public expenditure programmes, such as the
provision of free education and health.
Being able to reduce poverty gradually over the
years and having achieved the MDG of halving
poverty between 2000-2015, Sri Lanka now faces
the new challenge of ending poverty in all its forms,
everywhere, under the Sustainable Development
Goals (SDGs), which are expected to be met by
2030. In the Sri Lankan context, this highlights the
need to implement policies that will reach the extreme
poor, especially in peripheral districts.
The poverty map prepared by the Department of
Census and Statistics (DCS) and the Poverty Global
Practice of World Bank Group, based on data from
Sri Lanka’s 2012 Census of Population and Housing
(CPH) and the 2012/13 Household Income and
Expenditure Survey (HIES), highlights the presence of
significant geographical disparities among poverty
rates at the Divisional Secretariat (DS) level.4 For
instance, the PHCR in DSs in the Batticaloa district
vary extensively, from 5.3 per cent to 45.1 per cent.
Notably, all DS divisions in the Moneragala district
remain severely poor. While the presence of poverty
in certain districts is low, on an overall basis, some
DSs possess pockets of poverty, such as Akurana DS in
the Kandy district and Kinniya DS in the Trincomalee
district. The most significant geographical inequality
is observed in the gap between the PHCR of 0.6 per
cent recorded in the least poor DS of the country,
Dehiwala in the Colombo district, and the PHCR of
45.1 per cent recorded in Manmunai-West in the
3 Poverty and Welfare in Sri Lanka: Recent Progress and Remaining Challenges, World Bank,
2016, p.9.
4 The Spatial Distribution of Poverty in Sri Lanka, Department of Census and Statistics - Sri
Lanka and Poverty Global Practice, World Bank Group, August 2015.
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

Batticaloa district. The spatial distribution of poverty
also shows that high PHCR does not always indicate
that an equally high proportion of the population
is poor. This is reflected by the PHCR in Mullaitivu
and Mannar districts of 28.8 and 20.1 per cent,
macro-level initiatives encompassing the creation
of employment opportunities for unemployed
youth, enhanced public investment in infrastructure,
improved provision of public goods in rural areas
and designing social protection strategies targeting

1
respectively, accounting for only 3.4 per cent of the
the ageing population are also essential.
poor population of the country, whereas Kurunegala
accounts for 7.6 per cent of the country’s poor, with
a PHCR of 6.5 per cent. Income Inequality

“So distribution should undo excess, and

These regional disparities undermine the country’s each man have enough"
achievements so far in terms of overall poverty
reduction, and therefore, focused policy efforts are - William Shakespeare, English Playwright (1564-1616)
essential to address the remaining facets of overlooked
and acute poverty in the country. It is vital for policies Spatial Distribution of
Chart B.2.1
Poverty in Sri Lanka - 2012/13
Table B Poverty Head Count Ratio by Districts:
2.1 2009/10 and 2012/13 Poverty Head Count Ratio
Survey Period
District 1.4 - 3.4 Jaffna
2009/10* 2012/13
3.4 - 6.2
Colombo 3.6 1.4 Kilinochchi
6.2 - 9.0

ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

Gampaha 3.9 2.1 Mullaitivu
Kalutara 6.0 3.1 9.0 - 12.7

Kandy 10.3 6.2 12.7 - 37.3

Mannar
Matale 11.5 7.8 Vavuniya
Nuwara Eliya 7.6 6.6
Galle 10.3 9.9
Matara 11.2 7.1 Anuradhapura Thrincomalee

Hambantota 6.9 4.9

Puttalam Polonnaruwa
Jaffna 16.1 8.3
Mannar - 20.1 Batticaloa
Vavuniya 2.3 3.4
Mullaitivu - 28.8 Kurunegala Matale
Kilinochchi - 12.7 Kandy
Ampara
Batticaloa 20.3 19.4 Kegalle
Gampaha
Ampara 11.8 5.4 Nuwara Eliya
Badulla
Trincomalee 11.7 9.0 Colombo Moneragala
Kurunegala 11.7 6.5
Ratnapura
Puttalam 10.5 5.1 Kalutara
Anuradhapura 5.7 7.6
Polonnaruwa 5.8 6.7 Galle Hambantota
Badulla 13.3 12.3 Matara
Moneragala 14.5 20.8
Rathnapura 10.5 10.4
Source: Department of Census and Statistics
Kegalle 10.8 6.7
Sri Lanka 8.9 6.7
Source: Department of Census and Statistics
* Excluding Mannar, Mullaithivu and Kilinochchi districts Inequality in the distribution of income, consumption
or other attributes across the population is another
important aspect that needs attention. According to
to focus on the multidimensional nature of poverty, as
studies show that poverty spans over several aspects, Oxfam, in 2014, the richest 1 per cent of people in
inclusive of, but not limited to income. This includes, the world owned 48 per cent of global wealth, leaving
poor educational attainment, lower access to basic just 52 per cent to be shared between the other 99
amenities (such as safe water, sanitation, healthcare, per cent of adults on the planet.5 While inequalities
and nutrition), weak labour market linkages and an between countries have fallen slightly due to the growth
overall lack of access to productive economic assets.
in emerging countries, it is inequality within countries
As there is a legitimate right for the poor to have access
to the socioeconomic infrastructure of the country, the that matters most to people. In countries around the
government has the responsibility of addressing their world, a wealthy minority are taking an ever-increasing
issues on a systematic basis. In addition to increasing the share of their nation’s income. Given the implications of
coverage of government welfare assistance programmes this trend, the reduction of inequality within and among
to address the needs of the bottom quintile of the countries has been identified as one of the key goals
poor, it is important to ensure proper targeting to
under the SDGs.
improve the effectiveness of such programmes. Other
5 Oxfam Issue Briefing, Wealth: Having it All and Wanting More, January 2015

29
 CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015

Despite the improvement in Sri Lanka’s annual

per capita income from US dollars 981 in 2003 Chart B 2.2 Income Inequality-Share of Income
to US dollars 3,924 in 2015, significant income
inequalities continue to persist. According to the 4.5%
57.5%
latest 2012/13 HIES of DCS, the mean and median

1
Richest 10% of the
monthly household incomes were Rs. 45,878 and Households

Rs. 30,814, respectively. Considering district-level Middle 70% of the

Households
figures, the Colombo district recorded the highest Poorest 20% of
monthly mean household income (Rs. 77,723) the Households

while the Mullaitivu district recorded the lowest (Rs.

23,687). Accordingly, in terms of deciles, the highest
decile held 38 per cent of the household income in 38.0%
the country and the highest 20 per cent held 53 per
cent of household income. In contrast, 50 per cent
of the households accounted for only 20 per cent Source: HIES, 2012/13, DCS

of total household income, reflecting a significant

inequality in income distribution across the country.
Child Under-nutrition7

Table B “Hunger and malnutrition have devastating

Decile Groups and Share of Income consequences for children and have
2.2
been linked to low birth weight and birth
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES

Decile Group Share

Income Group of
Share of defects, obesity, mental and physical
All Groups Cumulative Income (%) health problems, and poorer educational
(Rs.per month) Income
(%) (Cumulative)
(%) outcomes”
1 10 Less than 10,836 1.5 1.5
- Marian Wright Edelman, Founder/President of the Children's
2 20 10,836 - 16,531 3.0 4.5 Defence Fund (CDF), USA8
3 30 16,532 - 21,286 4.1 8.6
The presence of hunger and under-nutrition in a
4 40 21,287 - 25,903 5.1 13.7
world of plentiful food denotes that extreme poverty is
5 50 25,904 - 30,814 6.2 19.9 an underlying cause of undernourishment. However,
6 60 30,815 - 36,758 7.3 27.2 under-nutrition, especially micronutrient deficiencies
are key causes of poverty as they affect the ability
7 70 36,759 - 45,000 8.9 36.1
of individuals to escape poverty. The impairment
8 80 45,001 - 57,495 10.9 47.0 of children’s ability to develop physically and
9 90 57,496 - 83,815 14.9 61.9 mentally can severely inhibit school attendance and
10 100 More than 83,815 38.0 100.0
performance, thus undermining the effectiveness of
investments in education and subsequently reducing
Source: HIES, 2012/13, DCS
productive potential as they enter the labour force.
Such individuals are then caught in a trap of hunger,
low productivity and chronic poverty.
According to HIES in 2012/13, the Gini coefficient6 of
the household income in Sri Lanka, which measures Sri Lanka faces a substantial burden of child under-
the extent to which the distribution of income among nutrition, with 13 per cent of all children under 5 years
individuals or households within an economy reported as stunted and 24 per cent as underweight
deviates from a perfectly equal distribution, stood at
in 2012. Across a range of standard indicators –
0.48. Although it reflects a marginal improvement
rates of anaemia, low birth weight (LBW), stunting,
of income distribution in comparison to 0.49 in the
previous HIES in 2009/10, there exists a strong need underweight and wasting – Sri Lanka’s performance
to implement appropriate policies to improve income is more comparable to countries with worse health
equality. outcomes than those with which it normally ranks
in health achievement. Despite the steady pace
6 The Gini index measures the extent to which the distribution of income (or, in some cases,
consumption expenditure) among individuals or households within an economy deviates
of economic growth and rising standards of living,
from a perfectly equal distribution. A Lorenz curve plots the cumulative percentages of total improvements in this area in the past decade have
income received against the cumulative number of recipients, starting with the poorest
individual or household. The Gini index measures the area between the Lorenz curve been slow and marginal.
and a hypothetical line of absolute equality, expressed as a percentage of the maximum
area under the line. Thus a Gini index of 0 represents perfect equality, while an index of 7 Based on “The Challenge of Child Under-nutrition in Sri Lanka” (Unpublished), Dr. Renuka
1 implies perfect inequality (The World Bank, http://data.worldbank.org/indicator/SI.POV. Jayatissa, Consultant Medical Nutritionist, Ministry of Health, Colombo, Sri Lanka.
GINI).
8 "Preventable Hunger in Our Land of Plenty", Children’s Defence Fund, USA

30
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
The United Nations Children's Fund (UNICEF) has
also made the following important observations on
child nutrition in Sri Lanka: 9
• Under-nutrition remains a key concern in Sri
Lanka.
• While stunting rates (13 per cent of all children
under 5 years) are lower than other countries in
the region, including Afghanistan and Pakistan,
they are higher than other middle-income Asian
countries such as China, Thailand and Malaysia.
• The prevalence of both childhood wasting and
underweight have increased since 2009 and
trends indicate that wasting is a serious concern
(more than 15 per cent of all children under 5
years) in 24 out of 25 districts.
• About half of stunted children and 27 per cent of
wasted children are younger than age two.
• About 2.3 per cent of under-5 children (40,000)
suffer from Severe Acute Malnutrition (SAM), while
more than four million Sri Lankans, particularly
women and children, are anemic.
• Significant disparities exist in the prevalence of such
conditions, across regions and income quintiles.
The problem of child under-nutrition in Sri Lanka is
concentrated in poorer families, the central hill country
and estates, and parts of the dry zone, specifically
North-Central Province, Kilinochchi and Moneragala.
The prevalence of LBW and child under-nutrition is
three times higher in the poorest families than in the
richest, and in the estates than in the rest of the country.
The leading causes of the poor performance of
Sri Lanka in nutrition indicators, are poverty, food
insecurity and the resultant poor health of mothers.
Of these, the single most important modifiable cause
in Sri Lanka is poverty and the food insecurity that
results from poverty, which in combination contributes
to more than two-thirds of the incidence of LBW, child
stunting and underweight. Food insecurity is reflected
not only in inadequate food consumption, but also in
the inability to obtain a healthy diverse diet.
Analyses of all national surveys between 1993 and
2012 consistently find that household income is the
leading modifiable determinant of LBW and stunting in
Sri Lanka, with the rise of incidence of stunting and LBW
in line with levels of poverty. Food availability in most
poor households is too low to ensure that everyone
achieves the minimally acceptable energy intake.
Accordingly, energy deficits are closely correlated with
income. The poorest households have energy intakes
equivalent to only two-thirds of those in the richest
households, thereby facing energy deficits of 2,000-
9 Nutrition, UNICEF, http://www.unicef.org/srilanka/Nutrition(1).pdf
3,500 calories per family per day. Considering that poor
families spend almost all of their income on food, they
are not able to close this gap themselves. Furthermore,
it is biologically implausible – even with the best medical
care – to expect that children in poor families can achieve
1
normal growth standards, or that calorie-starved mothers
can expect to deliver children of normal weight.
The modest improvement in under-nutrition indicators
contrasts with the 5–6 per cent annual growth in per
capita incomes that has been observed in Sri Lanka
since the 1990s. This is partly attributable to the unequal
sharing of economic growth. Much of the benefits
derived from this high growth trajectory has benefitted
the non-poor, with a poor trickle-down to the poor. This
has resulted in the lagging of the living standards of
the poor. Growing inequalities have caused a reduction
in the share of income received by the poorest 40 per
cent of Sri Lankans, from 15.3 per cent in 1996/97
to 13.7 per cent in 2012/13. This, coupled with the
weak targeting of government assistance, has weighed
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
negatively on the food security of the poorest Sri
Lankans.
Given the socioeconomic significance of the issues
underlying the prevalence of under-nutrition in the
country, in addition to the ongoing efforts by the
government, a multisectoral approach is required to
promote improved nutrition outcomes among the
poor. Furthermore, an effective national strategy must
consist of core interventions that provide effective and
adequate food supplementation to families at risk,
agricultural policies to enhance diversification and
local production and other micro-level interventions
that support, inform and supplement such core
interventions. Moreover, non-health interventions, such
as the provision of adequate funding for the capacity
building of health workers in the field of nutrition are
also essential to address this problem. Moreover, the
rising issue of over-nutrition amongst children, which
indicates a widening of inequality in nutrition levels,
also requires urgent attention, in order to prevent an
escalation of conditions such as diabetes and heart
diseases amongst the population in future.
Way Forward
The high growth trajectory that Sri Lanka is expected to
achieve and sustain over the medium-term will present
several opportunities to uplift the standards of living of
the population. However, the structural transition of the
economy has made it impossible for policymakers to
entirely rely on the “trickling down” of the benefits of
economic growth to uplift the vulnerable sections of the
population out of poverty. Therefore, it is imperative for
the government to consolidate and continue its efforts
to create a growth process wherein the entire populace
can not only contribute to but can also benefit from
the growth process, i.e., sharing prosperity through
inclusive growth.
31

population remain vulnerable as a result of poor
educational attainment, low performance in health
and nutrition indicators and lack of access to
basic infrastructure such as safe drinking water,
1 sanitation, and electricity as well as lack of financial
literacy and access to finance. The World Bank
noted in a Report published in 2015, that despite
the drastic reduction in poverty between 2002 and
2012/13, 1 in 4 people are nearly poor, defined
as those living above the official poverty line but
below US dollars 2.50 per day in 2005 PPP terms.
This depicts the high level of vulnerability among a
substantial share of the population, especially during
periods of economic shocks and natural disasters.
Notable poverty disparities between provinces
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
also highlight that certain provinces continue to
remain outside the ambit of the mainstream growth
process, unable to contribute to and benefit from
the high growth trajectory of the country, despite
the rapid development of physical infrastructure, in
the post-conflict era. This is further corroborated by
the inequalities in provincial contribution to GDP,
thereby highlighting the need to reorient policies to
create a growth process which is of an inclusive
nature. Such policies should address challenges
that arise from regional gaps that prevail in the
delivery of public services such as education and
health, infrastructure and connectivity, access
to labour markets and the availability of job
opportunities. The efficacy of such interventions will
depend greatly on identifying the individual needs
of lagging provinces and developing multi-sector
interventions that would cater to their specific
challenges. Proper targeting of these interventions
will not only ensure the rapid achievement of
the desired outcomes but also ensure financial
efficiency.
Effective measures are required to meet
the growing demand for high quality human
capital needs. With the structural transformation
the country has gone through in the past, from a
highly agriculture based economy towards an
32
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
industry and service sector oriented economy,
enhancing the manufacturing and service value-
added is important to reach these goals. It is
generally observed that an advanced industrial
sector is imperative to reach great heights in
economic and social development, apart from
a high performing services sector. In spite of the
low share of the agriculture sector in GDP, it still
remains the primary employer, accounting for a
share in employment of about 28.2 per cent. In
addition, the public sector accounts for about 15
per cent of total employment. This gives rise to
relatively low productivity gains while creating
labour shortages in other sectors. A decline in
agriculture sector employment is observed, which
is expected to continue but problems of direct
employability of these workers in industries and
services related activities remain, raising concerns
of labour mobility. It is observed that there is a
shortage of skilled labour of expected standards
necessary to embark on a higher growth trajectory,
which is a persistent issue faced by many industry
and service sectors. In this backdrop, human
capital development, as a means of increasing
industrial production and boosting competitiveness
through high value, high technology products and
services is a prerequisite in the attempt to avoid
the middle income trap. It will be worthwhile
considering the setting up of vocational training
or technical colleges following examples such
as Technical and Further Education Institutions
(TAFEs) in Australia or community colleges in the
US, to provide necessary knowledge and training
in the highly sought after skill categories, especially
targeting the export sector. In addition, revisiting the
existing technical colleges to expand and upgrade
them to meet the current needs, possibly with foreign
collaboration, too would be beneficial in meeting
the skill gaps, while creating opportunities for non-
entrants to local universities. Moreover, the rapid
advancement in technology that is taking place
in the global economy has implications for local
industries as well. These developments will bring
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
in a host of new challenges apart from the world of
opportunities, including the possibility of introducing
flexible work options. With rising wages and
relatively high manufacturing costs in comparison
to some other competing Asian countries, the need
for increased automation of industries is on the rise,
to enhance export competitiveness. There are a
few companies in Sri Lanka that have already opted
for increased automation and the use of robotics in
their plants. In this context, it is essential that the Sri
Lankan workforce is well equipped and dynamic to
meet the higher level skill requirements demanded
by these technology-driven developments. In
addition, steps should be taken to encourage Sri
Lankan expatriates with relevant expertise and
industry knowledge, while further encouraging
those who have already returned after gaining
academic, technical and professional qualifications
and experience from abroad, to impart their know-
how and help inculcate attitudes and best work
practices in the local industries.
The evolution of the current education system
into a demand driven one is essential for Sri Lanka
to capitalise on the substantial investment that it
has made in the education sector even prior to
independence and to sustain its achievements.
The commitment of successive governments to the
provision of universal access to education has helped
the country achieve near universal coverage of
primary and secondary education. Although Sri Lanka
possesses a highly literate population, the country
lags behind higher income economies in language
and numeracy skills. The education provided by the
system should hone the competencies of students,
helping them gain life skills while encouraging
independent thinking, rather than strictly following a
content based, examination oriented curriculum. This
can facilitate the development of market oriented
skills, e.g., language fluency, ICT knowledge, and
soft skills such as communication, leadership,
creativity and problem solving. At the tertiary level,
lack of high level research and development (R&D)
output necessary to support sustained economic
growth remains a challenge. The research exposure
of universities and other higher education institutes
has failed to reach the expected level to deliver the
envisaged advantages from higher education in Sri
Lanka towards achieving a competitive edge in global
trade and services. This would require stronger
1
innovation oriented institutional linkages between
the industry and academia, which could also help
transform the university structure into a self-sustaining
model. Further, Sri Lanka lags behind its middle
income counterparts in terms of enrolment in higher
education. This may be largely attributed to the limited
capacity of the public education system, while issues
such as availability and affordability limit the number
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
of opportunities available from the private education
sector. Considering the constraints on fiscal space,
increased private sector participation will help provide
the investment required to improve the productivity
and quality of output from the education system
thereby helping to improve the skill sets of school
leavers and graduates.
Chronic Kidney Disease of unknown etiology
(CKDu) has been a serious health issue in Sri
Lanka over the past two decades. CKDu was first
detected in the early 1990s from the North Central
Province and now poses a greater challenge due
to its rapid spread across around 10 districts in
adjacent provinces. In addition to Sri Lanka, CKDu
is seen in India, El-Salvador and Nicaragua. In Sri
Lanka, CKDu is attributed to several possible causal
factors, including high use of agrochemicals, hard
water, which include high levels of Calcium and
Fluoride, dehydration due to inadequate drinking
of water and heat, and presence or absence of
certain chemical compounds such as high levels of
Arsenic and Cadmium and low levels of Selenium.
Although a growing number of women and children
have been affected by CKDu, the majority of those
affected are male paddy farmers and agricultural
workers, who are the breadwinners of families. The
resultant loss of income due to the illness adversely
33

impacts the socio economic condition of the entire
family. Since Sri Lanka lacks a comprehensive
formal social support system, the loss of productivity
from the illness and the costs of care in terms of
1 consultation, drugs, dialysis and transplantation
could push families and communities to economically
unstable positions. High risk population screening
for early identification of the CKDu was started in
2008 by the Ministry of Health. Early identification
improves the longevity of the patients through
controlling their comorbidities such as Hypertension
and Diabetes, which are also chronic conditions
that will continue to increase the government’s
expenditure on health. Meanwhile, as a preventive
measure, the government banned the importation
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
of three pesticides, namely Chlopyrifos, Propanil
and Vabarly from April 2014 as some researchers
found that CKDu is caused by agrochemicals. The
government also introduced reforms to the existing
fertiliser subsidy scheme to discourage excessive
use of fertiliser and to encourage organic fertiliser.
Additionally, the government continues to support
CKDu patients through treatment modalities including
haemodialysis, kidney transplant programmes and
medication. Further, the government has taken steps
to provide Rs. 3,000 as a monthly allowance for the
diagnosed and economically unprivileged CKDu
patients. The National Water Supply and Drainage
Board (NWS&DB) provides water through RO
(Reverse Osmosis techniques) plants to the places
where pipe borne water is not available as a temporary
measure to provide clean water, but there is a strong
need of water supply projects to provide safe drinking
water for all the residents, particularly areas exposed
to the threat of CKDu, not only as a counter activity
against CKDu but also for the drive that all residents
in the country have access to clean drinking water.
Further, it would be vital to improve water quality
testing and lab facilities, safe drinking water supply
for schools and hospitals, hand pump rehabilitation
and existing rural water supply schemes in affected
areas with a view to controlling the epidemic.
34
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
Immediate improvements to public transport
are needed to curb the economic loss caused
by road traffic congestion. The transport network
of a country must be able to support economic
growth, growing population in cities and increased
movements between urban, suburban and rural
sectors. The inefficiency of the public passenger
transport system has resulted in increasing numbers
of private vehicles on the roads transporting fewer
numbers of passengers per vehicle leading to heavy
traffic congestion, causing increased fuel costs to
households and the economy and a substantial
loss of productive labour hours, which weighs down
the growth potential of the country. The associated
economic losses of congestion are expected to
increase further with the anticipated trend growth in
vehicle ownership caused by rising income levels.
Although the government has invested heavily in
transportation infrastructure development, such as
the building of roads and adding fleets of buses,
the issue of congestion persists due to the lack of
good quality and reliable mass transport options.
Hence, it is important to take appropriate measures
to improve the existing road and rail transportation
systems, especially in urban areas. Promoting
alternative modes of transport, such as establishing
safe and clearly demarcated cycle routes and
promoting the effective use of the canal network
for public transportation, could reduce congestion
to some extent. In the medium term, it is also
important for policymakers to adopt Transport
Demand Management (TDM) processes to apply
strategies and policies to promote efficient public
transportation modes and reduce travel demand
from single occupancy private vehicles, or to
redistribute this demand over space or time.
Ongoing changes in weather patterns and
volatilities associated with fuel prices reiterate
the need for strengthening the national policy
on renewable energy development, while
undertaking initiatives to overcome barriers to
increase the sustainability of low cost energy
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
generation in Sri Lanka. Although Sri Lanka has
exploited the energy production potential of all major
hydro resources, there are several other hydro
resources, including irrigation networks, capable of
making an invaluable contribution to the energy mix,
which remain untapped. It has also been identified
that there is considerable wind power potential in
the country, particularly in Mannar, Puttalam and
Jaffna as well as hill-country areas. Further, readily
available biomass resources, agricultural waste
and municipal solid waste also possess immense
potential to generate a sizeable amount of power.
Solar power is also another readily available
source of electricity that Sri Lanka is not adequately
harnessing, despite its high level of scalability, high
level of accessibility and contribution to greener
energy. It is necessary to bring together the industry
experts and policymakers to assess the potential
of such renewable energy sources and investigate
innovative means of overcoming the technological,
financial and economic constraints in the use of
such resources. Such policies should focus on the
attraction of private sector participants for micro
level projects, long-term unsubsidised economic
cost analysis of competing resources, dynamic
prioritising mechanism, and the availability of long
term and low cost financing, which will enable
the country to reap benefits offered by renewable
energy. In the meantime, continued efforts are
necessary to encourage practices of energy saving,
both in residential and business sectors.
Having a robust pricing formula for domestic
petroleum products is essential to ensure
the commercial viability of the CPC, while
passing the effects of global oil price variations
transparently to domestic users. World crude oil
prices are constantly exposed to global supply and
demand shocks and expectations, and maintaining
domestic prices of petroleum products at a
particular level for long periods will create a burden
either on domestic oil suppliers or consumers. A
pricing formula that takes into account the Free
On Board (FOB) price, freight and insurance
costs, exchange rate, port charges, taxes and
duties, levels of locally refined and refined import
volumes and sales and administration costs, could
minimise these externalities. The pricing formula
could be strengthened with a rule that determines
the frequency, a trigger level for revision and
1
the quantum of change to be imposed on the
current retail price, probably as a percentage
of the total cost. Therefore, the current efforts of
the government to introduce a pricing formula for
domestic petroleum products must be encouraged
as a step in the right direction. In the meantime,
adopting cost reflective pricing mechanisms in
relation to other key public utilities is also necessary
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
to minimise losses of SOEs.
The agriculture sector is saddled with
major issues such as low productivity, lack of
diversification, food insecurity and inefficiency
in water management as well as the natural
challenge of climate change. Therefore, the
necessity for the revitalisation of this sector with large
investment in the areas of agricultural research,
development of water resources and infrastructure
facilities is often highlighted. It is also necessary
to facilitate the shift from traditional low value
to modern high value agriculture, accompanied
by improved diversification, productivity and
competitiveness, while making an attempt to reform
current agriculture policies to drive the sector into a
higher growth trajectory and thereby increase food
security. Further, encouraging scientific farming,
promoting agro-based industries and initiating
commercial agriculture with the participation of
both farmer organisations and the private sector
are essential for equity based development and
to improve yields. At the same time, diversifying
into high value added agricultural products would
be a significant factor to enhance agricultural
growth, particularly in rain-fed areas. In this
regard, measures should be taken to expand agro
processing and link producers with urban centres
35

and export markets. Attention should also be paid
towards strengthening agricultural research and
extension services, which had suffered over the
years owing to underfunding of infrastructure and
1
limited access to state-of-the-art technologies, for
the expansion of the sector. Meanwhile, increased
competition for water by many stakeholders,
including industry, domestic and agriculture
sectors, emphasises the necessity of improving
water resource management, more efficient
delivery mechanisms and irrigation systems to
enhance the efficiency of irrigation.
Increasing cost of production, outdated
machinery, low yields, old age of crops, low
value addition and inadequate diversification
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
remain key issues in the plantation sector. These
issues highlight the need for replanting, cultivation
of better crop varieties, effective usage of fertiliser,
pest management practices, diversification,
improved manufacturing and value addition and
the establishment of effective marketing channels.
Meanwhile, the decline in commodity prices, along
with the escalated cost of production, remain key
challenges that impede the growth of both rubber
and tea industries. It is noted that although a large
number of crops cultivated in Sri Lanka have
considerable potential to be developed in various
agro-processing industries, most of the crops are
exported as a primary commodity, without much
value addition. Hence, greater efforts are necessary
from all stakeholders to make the plantation sector
more profitable and sustainable.
In order to create an enabling socioeconomic
infrastructure and lucrative livelihood
opportunities amidst constraints on public
resources, the government will have to actively
consider innovative mechanisms, such as
Public Private Partnerships (PPPs), to meet the
rising funding gap. Sustained public investment
in essential infrastructure, such as education,
health, electricity, roads and highways, contributed
to Sri Lanka’s rapid transition into a middle-income
36
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
country. However, the country has immense
potential to benefit from alternative financing
models that will help leverage private sector capital
and expertise across all sectors of the economy.
While private sector financing can help ease public
sector debt and expenditure burdens, private sector
financing in PPPs can induce crowding in of private
sector investment, as successful PPPs help in the
development of robust institutional arrangements
and instil confidence that will stimulate activity
across other sectors. The involvement of the
private sector can also lead to more effective
and efficient service provisioning due to their
competitive nature. However, the onus of the
success of attracting private sector participation
and reaping the benefits of such strategic
partnerships lies in the government’s ability to set
and enforce standards that will ensure appropriate
safety, service quality and pricing. Therefore, the
public sector will have to uphold good governance
in its role as regulator, facilitator and the ultimate
policy maker. The government may also actively
encourage the financial sector to contribute to these
initiatives through the development of the domestic
bond market and through policy initiatives to
create infrastructure debt funds, both of which can
facilitate the issuance of infrastructure bonds. The
success of attracting private sector participation
and reaping the benefits of PPPs will largely
depend on the government’s policy consistency
and commitment, and the creation of a conducive
legal and macroeconomic environment.
With the acceleration of population ageing,
there is a need to ensure the sustainability
of the public sector pension scheme, while
introducing market oriented pension and
superannuation schemes that ensure a wider
coverage of the labour force. The rise in the
number of pensioners and pension allowances, is a
significant recurrent expenditure in the government
budget. The associated financial burden is not
expected to subside over the medium term as a result
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
of the gradually ageing population and increasing life
expectancy. This demographic transition underscores
the need for the development of savings and pension
products to cater to the requirements of this rising
share of the population that is reaching retirement
age. The urgency to develop these products is
intensified by the comparatively low level of interest
rates prevailing in the market and the dependence of
many retirees on interest income. While a few financial
institutions have already introduced some products,
there is a need for further development of alternative
savings and pension products, such as annuities,
superannuation schemes and pension plans, to cater
to the needs of long term savers. The introduction of
such products while providing a cushion for retirees
would also facilitate the development of the financial
sector and be a source of long term funding for
projects with long gestation periods. Meanwhile, a
contributory pension scheme has been proposed
in the Budget for 2016, for new recruits to the
government sector, to ensure the sustainability of
the public sector pension scheme.
Financial deepening through the raising
of efficiency of financial intermediation,
introduction of a diverse range of financial
products and services, and improving access
to formal finance would be pivotal to the
sustenance of the high growth momentum of
the economy. Financial development increases
the resilience of the economy, while boosting
economic growth through the mobilisation of
savings, promotion of information sharing,
improvement in resource allocation, and facilitation
of the diversification and management of risk.
Financial development can also promote financial
stability as deep and liquid financial systems with
diverse instruments can dampen the impact of
shocks. Accordingly, while the banking sector
continues to be the key provider of financing for
the corporate and SME sectors, there is a need to
introduce and promote alternative market based
financing methods to ensure adequate availability
of long term financing, catering to the diverse needs
of the economy. This is essential for the effective
implementation of policy measures targeted
at boosting private sector investment activity.
1
Accordingly, more focus should be placed on the
development of deep and liquid corporate debt
markets over the medium term, while undertaking
initiatives to improve the depth of the equity
markets through increased market participation
of both local and foreign investors. As the country
aspires to emerge as a regional financial center,
the gradual development of proficient and liquid
currency, derivatives and commodities markets
to accommodate complex financial instruments,
and the development of a dynamic and globalised
regulatory regime is also important. Meanwhile, the
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
lack of a well-developed private equity and venture
capital industry continues to remain a concern, as
the presence of such industries can help catalyse
the economy’s transition towards a knowledge
driven one as has been seen in the spurt of
venture capital flows to emerging markets such
as Malaysia, Vietnam, Philippines and Indonesia.
The development of the financial sector can also
cater to several unmet needs of the economy such
as improving access to finance in economically
backward regions, development of alternative
savings and pension products to cater to the needs
of long term savers, and the financing of innovative
initiatives such as those related to renewable and
alternative energy.
The strategic position of the island of Sri
Lanka in the Indian Ocean in the middle of the
maritime silk route from China to Europe must
be exploited to harness the potential of the
country. In addition to locational advantage, Sri
Lanka’s strengths, including its educated workforce,
improved physical infrastructure, relatively easy
doing business environment in the region, relatively
low tax regime, political consensus on broad
policy direction on macroeconomic issues as well
as the rapid growth in the region, can be used to
promote the country as a key investor destination
37

in the region. Although Sri Lanka is identified as
a part of the South Asia block, the country shows
more differences than similarities in comparison
to the other countries in the region in terms of
1 socio-economic development. This enables the
country to exploit opportunities in the region and
provides a unique opportunity to connect both
with the East Asian economic giants as well as
the advanced economies in the West. Sri Lanka
could also leverage competencies and advantages
in logistical services as Sri Lanka is potentially
an integral part of the global value chain. In this
regard, concerted efforts are necessary to enhance
investor confidence and brand Sri Lanka as the
most open, globalised and competitive economy
ECONOMIC, PRICE AND FINANCIAL SYSTEM STABILITY, OUTLOOK AND POLICIES
in South Asia in the medium term and regain its
position as the Indian Ocean hub for trade and
investment.
38
CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2015
The year 2015 highlighted the structural
vulnerabilities of the economy that had built
up over time, and decisive steps are necessary
to correct these vulnerabilities to ensure the
country’s progress along a high growth – low
inflation path. Short term fiscal and monetary
stimuli are inadequate to support economic
growth continuously, and tightening policy spaces
and resource constraints point to the fact that
such short term stimuli are no longer affordable.
Therefore, it is necessary for the country to adopt
a proper blend of structural reforms, including fiscal
reforms on revenue and expenditure fronts as well
as with regard to SOEs, ensure policy consistency
and improve the ease of doing business in order
to attract non debt creating capital flows. These
reforms must aim at harnessing and synergising
the country’s strengths, including its human capital,
with greater participation of the private sector.